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 Third Quarter 2022 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 third quarter 2022 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 third quarter 2022 earnings conference. Today, we will first have Mr. Junjun Tang, our Executive Director and President, make some remarks on our third 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. 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] Hua Hong Semiconductor maintained its positive performance in the third quarter of 2022. The company continues to see strong demand for all specialty technology platforms, especially for nonvolatile memory and power discrete. All our 8-inch and 12-inch fabs remain fully utilized, and average selling prices increased both year-on-year and quarter-on-quarter.

[Foreign Language]

[Interpreted] Revenue was USD 629.9 million, another record, up 39.5% year-on-year and 1.5% quarter-on-quarter. Gross profit margin also reached a record high of 37.2%, 10.1 percentage points above a year ago and 3.6 percentage points over the previous quarter.

[Foreign Language]

[Interpreted] Serving the world as a China-based company, we will keep focusing on the emerging markets such as industrial applications, automotive electronics and new energy. And to seamlessly innovate in the specialty technology territory, we'll go full speed ahead with a 12-inch capacity expansion project, deeply integrating the global IC industry supply chain, improve our core competitiveness and provide customers with high-quality, reliable, efficient, diversified and comprehensive product solutions.

[Foreign Language]

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

Thank you, Mr. Tang, for your comments. Now let me begin with a summary of our financial performance for the third quarter followed by an outlook on revenue and margin for the fourth quarter 2022. Then we will move on to the question-and-answer session. First, let me summarize our financial performance as of the third quarter. Revenue reached another all-time high of $629.9 million, up 39.5% year-over-year and 1.5% above the prior quarter. Cost of sales was $395.9 million, 20.2% over Q3 2021, largely due to increased wafer shipments and depreciation costs; and 3.9% below Q2 2022, mainly due to decreased wafer shipments. Gross margin rose to 37.2%, 10.1 percentage points higher than Q3 2021, primarily due to improved average selling price, partially offset by increased depreciation costs; and 3.6 percentage points above Q2 2022, primarily due to improved average selling price. Operating expenses were $73.6 million, 1.8% over Q3 2021 and 4.2% above Q2 2022. Other cost net -- I mean other loss net was $57.8 million versus other income net of $7.5 million in Q3 2021, primarily due to increased foreign exchange losses; and flat to Q2 2022. Income tax expense was $37.2 million, 70.5% above Q3 2021, primarily due to increased taxable income. Profit for the period was $65.4 million, 83.7% above Q3 2021 and 22.9% over Q2 2022. Net profit attributable to shareholders of the parent company was $103.9 million, 104.5% above Q3 2021 and 33.8% over Q2 2022. Basic earnings per share was $0.08, 105.1% above Q3 2021 and 25% over Q2 2022. Annualized ROE was 14.4%, 6.8 percentage points higher than Q3 2021 and 2.9 percentage points above Q2 2022. Now I will discuss the operating results for both the Hua Hong 8-inch wafer fabs and the Wuxi 12-inch wafer fab. First, let's have a look at the Hua Hong 8-inch wafer fabs. Revenue was $384.2 million, 22.1% over Q3 2021 and 8.5% above Q2 2022. Gross margin was 46.7%, 11.5 percentage points above Q3 2021 and 2.5 percentage points over Q2 2022, largely due to improved average selling price. Operating expenses were $34.1 million, 20% lower than Q3 2021, largely due to decreased labor expenses, partially offset by decreased government grants for research and development; and flat to Q2 2022. Profit before tax was $178.9 million, 119.4% over Q3 2021 and 26.1% above Q2 2022. Now let's have a look at the performance of the Hua Hong Wuxi wafer fab. Revenue was $245.7 million, 79.7% over Q3 2021 and 7.9% below Q2 2022. Gross margin was 22.3%, 13.8 percentage points above Q3 2021 and 2.7 percentage points over Q2 2022, largely due to improved average selling price. Operating expenses were $39.5 million, 33.1% above Q3 2021 and 11.3% over Q2 2022, primarily due to increased research and development expenses. EBITDA was $24.1 million, 19.6% below Q3 2021 and 15.9% under Q2 2022, largely due to increased foreign exchange losses. Now I would like to provide more details on our revenue from Q3 2022. From geographical perspective, revenue from China was $452.3 million, contributing 71.8% of total revenue, an increase of 36.5% over Q3 2021, mainly due to increased demand for MCU, power management IC, smart card ICs, NOR Flash, IGBT and super junction products. Revenue from the United States was $80.5 million, an increase of 67.9% over Q3 2021, mainly due to increased demand for other power management IC and MCU products. Revenue from Asia was $55.7 million, an increase of 25.8% over Q3 2021, mainly due to increased demand for logic and MCU products. Revenue from Europe was $30.3 million, an increase of 45.2% over Q3 2021, mainly due to increased demand for general MOSFET, smart card ICs and IGBT products. Revenue from Japan was $11.1 million, an increase of 57% over Q3 2021, primarily due to increased demand for MCU products. With respect to technology platforms, revenue from embedded nonvolatile memory was $213.8 million, an increase of 69% over Q3 2021, mainly due to increased demand for MCU and smart card ICs. Revenue from stand-alone nonvolatile memory was $43.5 million, an increase of 118.6% over Q3 2021, primarily due to increased demand for NOR Flash products. Revenue from discrete was $191.4 million, an increase of 25% over Q3 2021, mainly due to increased demand for IGBT and super junction products. Revenue from logic and RF was $59.1 million, a decrease of 26.2% compared to Q3 2021, mainly due to decreased demand for CIS products. Revenue from analog and power management IC was $121.8 million, an increase of 71.3% over Q3 2021, mainly due to 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 $158.6 million, 4.5% over Q3 2021 and 25.3% below Q2 2022. Capital expenditures were $428.7 million in Q3 2022, including $390.3 million for the Wuxi fab and $38.4 million for the Hua Hong 8-inch fabs. Other cash flow generated from investing activities was $28.7 million in Q3 2022, including $16.6 million of interest income, $9 million of receipts of government grants for equipment, $5.7 million of receipts from selling an equity instrument and $1 million (sic) [ $0.1 million ] of receipts from disposal of equipment, partially offset by $2.7 million of investment in associates. Net cash flows generated from financing activities was $579.7 million, including $392 million of capital contribution from the noncontrolling interests, $248.8 million proceeds from bank borrowings and $3 million of proceeds from share option exercises, partially offset by $62.2 million of bank principal payment, $1.6 million of interest payments and $0.3 million of lease payments. Now let's move to the balance sheet. Cash and cash equivalents was $1,984.2 million on September 30, 2022, compared to $1,707.7 million on June 30, 2022. Inventories increased from $473.9 million on June 30, 2022, to $509.6 million on September 30, 2022, primarily due to increased finished goods and raw materials. Property, plant and equipment was $3,140.2 million on September 30, 2022, compared to $2,955.5 million on June 30, 2022. Total assets was $6,660.4 million on September 30, 2022, compared to $6,240.7 million on June 30, 2022. Our total bank borrowings was $1,778 million on September 30, 2022, compared to $1,578.3 million on June 30, 2022, mainly due to increased short-term bank borrowings. Total liabilities increased to $2,800.8 million on September 30, 2022, from $2,608.9 million on June 30, 2022. Debt ratio increased to 42.1% on September 30, 2022, from 41.8% on June 30, 2022. Finally, let me give you a high-level outlook for the fourth quarter 2022. We expect revenue to be approximately $630 million and our gross margin to be in the range of 35% to 37%. This concludes my financial remarks. Now we would like to start the question-and-answer session. Operator, please. Thank you.

[Operator Instructions] I'll take the first questions from the line of Randy Abrams from Credit Suisse.

This is Angela on behalf of Randy. So I want to ask you in terms of your performance by technology platforms. We saw that CIS and NOR has declined sequentially. So I want to ask if we should expect that to continue. Or do you see any near-term trends around? And are the other areas such as discrete and MCU holding up? Or do you see any signs of slowdown in those stronger areas as well? And for your next 30,000 capacity, has these relative strength and weakness seen in these platforms change any of your capacity allocation strategy? That's my first question.

[Foreign Language]

[Interpreted] Thank you for your question. I think most of you is understanding that the current market situation is not that good, especially for the consumer electronics as of the mobile phones is not that good.

[Foreign Language]

[Interpreted] For our 3 8-inch production lines, as for now, they are not impacted, and we have full purchase orders going on.

[Foreign Language]

[Interpreted] Because of the consumer electronics, our logic platform in the 12-inch fab is decreasing a little bit, but we have done some capacity optimization in the previous months. So we put some more MCU to offset the decrease of the larger platforms. We also do some more highly power discrete.

[Foreign Language]

[Interpreted] So from our accounting financial report, you can see we are increasing our investment in the R&D. And after 2 years R&D, the input, we have built a strong platform for our new products and new technologies.

[Foreign Language]

[Interpreted] And new orders coming from our new MCU, BCD, highly power discrete and IGBT, they can afford our future growth for our capacity expansion.

[Foreign Language]

[Interpreted] We also see the market estimate that we will see a turning point by the middle of next year. So to the whole industry, we can see growth.

My next question is on your A-share listing. Congrats on getting the application accepted by the exchange. So is there any like when can -- can we have any clarity on when we could expect the listing? And on that, can you clarify the time line for the next 12-inch fab, including when we should expect fab construction, equipment move-in and the capacity ramp to be done? And what's the full capacity potential of the fab and the total CapEx required?

Okay. So the work related to the IPO, the stock market has been moving along very smoothly. On November 4, as you know, the company is filing for an IPO, were officially accepted by the Shanghai Stock Exchange and are now officially under review by the exchange. We expect a very quick approval. It would take probably about 2 to 3 months, okay? So as far as the 12-inch fab, I think we expect sometime next year, first half, we should start the construction work.

[Foreign Language]

[Interpreted] For the new Wuxi fab, we are undergoing the internal procedures. And as soon as we have official decision, we will let you know at the first time.

Okay. [ I'm trying to find ] that -- yes, I noticed on the filing that indicated the total investment on the fab would be around USD 6.7 billion and expected to reach a full capacity of 83,000 wafer per month. Is that the direction we should model our assumptions around?

Yes, that's a good assumption. It's going to be -- the build-out will be in stages. I think the first stage is around 60,000 to 70,000 wafers capacity. That will -- as you said, you can use that assumption as the first stage.

Next question comes from the line of Leping Huang from Huatai.

Congratulations for the results. The first question is about your Wuxi fab's expansion plan. So are you on track to add this, I remember, 30,000 wafer per month capacity in fourth quarter? And if your new fab is still under planning, so if the demand remains strong, so do you have any extra room to add in the first half next year based on your current facility?

[Foreign Language]

[Interpreted] Yes. Thank you for the question. We have completed our structure target for the Wuxi Phase 1 project as well as the project plan. So during the process, we have implemented 2 phases of capacity expansion.

[Foreign Language]

[Interpreted] So for the first phase, the capacity expansion, we expanded our monthly capacity to 65,000 per month. We have already completed by first half of this year. We -- as for the current wafer start and wafer out, we have already exceeded that target.

[Foreign Language]

[Interpreted] So we are now in the process of the second phase capacity expansion. About 50% tools has already been moving in. Now we are pushing the schedule for the tools installation and adjustment.

[Foreign Language]

[Interpreted] Because of the process technology introduction and the adjustment of the tools, this part of the capacity will be released gradually in the first half next year.

[Foreign Language]

[Interpreted] And this part of capacity will be focusing on our 5 major technology platforms.

Just a follow-up. So how much is the -- based on current knowledge, so how much is the Phase 2 you are at from -- by sometime next year?

[Foreign Language]

So a little bit less than 30,000, around 30,000 from, 65,000 to 94,500.

Okay. So the second question is just help us to -- because we see a very large change on the end demand. So do you think the exchangeable of your capacity between the power discrete and the logic platform, so -- since you just mentioned you do some arrangements to shift the [ part on ] MCU to the power side. So is it possible? How much existing 65,000 wafer Wuxi fab can be adjusted to more power focus? I think, if I remember correctly, [ 1/3 ] was power before, right?

[Foreign Language]

[Interpreted] So there's not that much to do to exchange between logic and discrete. What we do is to exchange some larger capacity into MCU and analog.

Okay. One more question is we see the U.S., the new export restriction. So what's the impact of the U.S. export restriction on your business, especially when you're planning for the new capacity expansion and also the stability of your U.S. presence looking forward?

Leping, let me just answer that. These new controls are direct at the semiconductor fabrication facilities in China that develop or produce, one, logic integrated circuits using [ NAND ], plan their architecture or with the production technology nodes of 16/14-nanometer or less, NAND memory integrated circuits with 128 layers or more or DRAM integrated circuits using a production technology node of 18-nanometer half pitch or less. The scope of this rule does not include the fabs involved with production of ICs above 16-nanometer. So Hua Hong Semiconductor is not applied, has no impact.

So if I understand correct, so now the U.S. equipment vendors still can work normally in your fab. Is my -- since there are some concerns that some equipment vendor need to leave the Chinese fab. So is it my understanding correct?

There's absolutely 0 impact.

We have -- the next question comes from the line of [indiscernible] from [indiscernible] Securities.

Dear management, I'm [indiscernible] from [indiscernible] Securities. I have 3 questions. So the first is about our utilization rate. As we know, currently, our 8-inch and 12-inch utilization rate is above 100%, but the demand seemed to drop rapidly. So can you give us a preview about what will the utilization be in the next 2 quarters, like 80% or 90%? And how can we verify it just, I mean, for 8-inch and 12-inch? That's the first question.

Thank you for the question. Our utilization rate for the 3 8-inch fabs continue to run at above 100% at this point. It is -- actually, we're in the above 110% utilization rate at this point. In the 12-inch fab, yes, we did have some impact. The demand for CIS product has come down. But it was quickly swapped with other products such as embedded nonvolatile memory, MCU or smart card ICs and some allocated to power management -- to logic and RF and even power management IC. So the 12-inch fab continue -- also continues to run at more than 100% utilization rate. We expect that will continue. This trend will continue, will continue into next year.

Okay. My second question is about the gross margin. So we see the guidance about the next quarter, the GPM seems to go down. So how long will the recession be? And will the first quarter 2023 be the worst season?

Well, good question. Our gross margin, if it's anything, it actually picked up within the first 3 quarters, okay? We were now officially at above 37%, and our 3 8-inch fabs reached -- in Q3 reached 47%, okay? And the 12-inch fab also this past quarter reached 22%, okay? I think -- we're hoping this trend will continue, will continue as long as we can keep the demand going. As long as the demand is strong, this trend should continue, okay? We certainly have every desire to make sure that our overall utilization rate will continue to improve next quarter as well as for next year.

Okay. Very clear. So my last question is about equipment. So will our equipment move-in get delayed? And what will be the reason if it's delayed?

I wasn't sure about your question, but there is actually no delay in terms of getting the equipment at this point. So we don't expect that -- the additional 30,000 wafers that Mr. Tang referred earlier, the equipment for the 30,000 wafers all virtually arrived in our fab. And we don't expect there will be any delay for the ones that were -- that are actually on the way.

The next question comes from the line of Szeho Ng from China Renaissance.

I have 2 questions. First one, regarding the revenue mix. I've seen that industrial and automotive have been ramping up pretty nicely as a percentage of revenue. Can we assume most of the upside actually coming from automotive?

Szeho, it is actually both. It comes from -- one from industrial, and secondly, also from automotive applications.

I see. Yes. Can you actually break it down between the 2? Yes.

You're talking about industrial and automotive?

Right, right, right. Because you lump the 2 together, yes.

Yes, yes. I would say at this point, industrial, it's a very important segment for us. It has been growing very, very fast. Most of the products within that group are MCUs and things like IGBT and super junction, okay, IGBT. But I would expect that the segment for automotive will also -- is also going to very fast in the next few years. So at this point, I would say around 80% is -- belongs to industrial and about 20% goes to automotive -- I mean, goes to auto related.

Right, right, right. Good. Yes. But for automotive, can we assume it to grow at a very significant pace in the next 2, 3 years?

Absolutely. I mean automotive is going to be the future. I mean even though industrial has been growing fast, very fast for us, but I think for the next 3 to 5 years, I think the demand in automotive, in particular, for things like IGBT, super junction, MCU will surge. So I'm just saying that automotive would be very, very important for us.

Okay. That's nice yes. Second question, going back to the P&L, yes. For the last 2 quarters, the company actually booked FX losses. So would the company consider to do more hedging going forward? Or will you just leave it like that?

It's a very good question. We have already done a lot, okay? You have to realize all the quotes were priced at dollars, is dollar-based, okay, all dollar-denominated. And we use 3 months' average FX rate to translate that into renminbi, okay? So -- and there are many things we're doing just to make sure that impact will be minimized. We have just received the $800 million equity in yuan during the past quarter. We immediately convert about half of that into dollars. So by just doing that, we basically minimized the FX loss. So there are many things we're doing just to make sure that we will have little effect on the -- on this -- with this FX impact.

Okay. So basically, we can consider the impact in the last 2 quarters as short term, right?

Right. I think so. I mean it's going to be short term. I think -- I expect renminbi will bounce back in the future. And when that happens, I think basically, it's going to offset the loss we had in the past 2 quarters.

Right, right, right. Okay. Good.

You have to remember, for the past many years, we actually had many FX scares. You have to realize that, which if you look at long term, the impact is very small.

I see. All right. Got you. And last one, for the power discrete volume, can you share with us the breakdown, like the IGBT, super junction and trench [indiscernible], things like that for the recent quarters?

Sorry?

The breakdown of your power discrete portfolio, yes, for major products like IGBT and super junction.

Well, IGBT, I think for -- I mean for discrete this year, it's going to be around 30% of our revenue, okay? So IGBT is probably going to be -- of the 30%, IGBT is going to be around 9 percentage points. Super junction is going to be around 10%. And then the split gate trench were probably around 6% to 7%, and DMOS is going to be about 6%.

We have the next question from Charles Shum from Bloomberg.

I just want to have more clarity on your operation status in the third Q. I'm aware that you actually -- you mentioned that your shipment number actually in the 12-inch fab is actually less than the previous quarter. So in this case, can I know -- but at the same time, you still -- you say that your capacity is still at 65,000 per month. So can I know why is the final shipment number is actually less than the previous quarter?

Sure. So the capacity for the 12-inch fab is at about 65,000 at this point. But our loading -- because of the efficiency and the product mix change, our loading is actually more than 70,000 wafers. So that number changes because of product mix, okay? Product mix. So -- but our ASP continued to improve throughout the quarter for both the 8-inch and the 12-inch fab, okay? So it's just -- overall, it's just the -- it's a change because of the product mix.

Okay. But then how do you still get that overload capacity utilization rate?

Well, as I said, the capacity is running -- the official capacity is 65,000. We're running above 70,000 wafers.

Okay, okay, okay. Got it. All right. And then my second question is about the -- your inventories. Actually, I looked, it's still going up this quarter. And I just want to hear, well, your opinion, when you think that turnover day will start coming down.

I think just overall, the inventory level is very normal at this point. It's just basically finished goods and raw materials. I think over the past few quarters, we have been -- because of the demand, I think we have increased our stocking for the raw materials. So that will -- we're going to be pretty much keep it at that level.

So you mean even for the next year, you're also still expecting that over 100 days the normal level?

I think it will change. It's going to bounce around 90 to 100 days.

Okay. Got it. Got it. All right. Can I also ask one more -- yes, please.

Yes. You got to have enough materials -- raw materials and spare parts to get the fab going when the fab is loaded more than 100%. And at the same time, you have finished goods coming out as well. So that we need to basically push them out of the production line and the inventory.

So you haven't received any requests from your customers saying that they want you to postpone the shipment because of the business change? You haven't received such a request. Am I correct?

No. No.

Okay. Can I ask one more thing about your gross margin? You're showing a very healthy growth trend for your gross margin than in the past 12 months, and it's going to extend to the fourth quarter based on guidance. So that's actually 44 percentage for your 8-inch wafer and also 22% for your 12-inch wafer fab. In this case, actually, I looked at the previous history actually before the call, and the 8-inch fab is only around 20% or something like that. So for this 44 percentage gross margin, do you think it could be sustained into the next year or something like that?

That's a very, very good question. Very good question. As I said earlier, I mean, we continue to believe that the fabs will be fully loaded going forward. That is -- we're very -- extremely confident with the 3-inch fabs. The 12-inch fab is also doing extremely well, okay? It is loaded currently at more than 100%, okay? We can -- we're able to ship products between different technology platforms very, very quickly. That's our flexibility. So when one thing, for example, CIS, demand for CIS come down, we can quickly replace that portion of the capacity with other things like MCU and power management IC, okay? So we continue to expect the fab will be fully loaded at extremely -- full utilization rate. As long as we're doing that, as long as the demand continues to be very strong, we have room to improve our price. As I said, we're hoping, in the long term, we want to get the 12-inch fab to 30% gross margin when we get to 95,000 wafer capacity. And then we want to get the 3-inch fab to, for example, 50% gross margin. That is -- we're not too far from that. But the overall environment is not the most desirable. We understand that, but there are room that -- we're specialty technology platforms, we're very, very different from other companies. I mean virtually, if you look at [indiscernible], I mean, most of the fabs are running at around 60%, 70%. But we continue to run the -- all 4 fabs at 100% utilization rate.

We have follow-up questions from the line of Randy Abrams of Credit Suisse.

No, sorry, I don't have questions.

We do have a last question. There's follow-up questions. Last question is from the line of Leping Huang of Huatai.

Okay. So what's the -- considering the change of the product mix and looking forward and because I think logic and the MCU or the analog has different [ mask ] or different platforms. So what we should look -- also the power is increasing. What -- how should we model your ASP trend in the fourth quarter?

Leping, can you please repeat that question again? I didn't quite get it. Leping?

Should we take the next question?

Sure.

We do have questions from the line of Hanqing Li from CMBI.

Congrats on your third quarter results. And I think my question was around your product mix. I know that the consumer electronics consists about -- a large portion. And I would like to ask, how much of the smartphone actually or CIS related were accounted for and how much home appliances were accounted for that category? And can you give us a little bit of outlook of how you see the CIS in the future?

Basically, for CIS, we had about 10,000 wafer capacity. It comes down to about 2,000 at this point. But that capacity was quickly absorbed by other products, other products like MCU and power management IC. Our -- overall, the cell phone business, very little, very little. It's about -- just overall, CIS related and some of the MCUs, but just I think -- I would say, around 5%.

I would like to follow up a question on your CapEx expenditure. Did you actually give guidance on your 2023 CapEx at this point?

Sure. It's -- I think for the 12-inch fab, it's probably going to be around $600 million for -- mostly for upgrades and optimization. And for the 3-inch fab, it's going to be around $150 million to $200 million.

Ladies and gentlemen, that's all the time we have for questions. I will now hand back to the management for closing remarks.

Again, I want to thank you all for joining us today and asking all the great questions. We hope you will join us again next quarter. So the holiday season is not too far away. Please continue to stay safe and healthy. And I hope that we can meet in-person very, very soon in the future. Thank you.

Ladies and gentlemen, thank you for your attendance. You may now disconnect. [Portions of this transcript that are marked [Interpreted] were spoken by an interpreter present on the live call.]