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Edited Transcript of 1347.HK earnings conference call or presentation 7-Aug-19 8:00am GMT

Q2 2019 Hua Hong Semiconductor Ltd Earnings Call

SHANGHAI Aug 14, 2019 (Thomson StreetEvents) -- Edited Transcript of Hua Hong Semiconductor Ltd earnings conference call or presentation Wednesday, August 7, 2019 at 8:00:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Junjun Tang

Hua Hong Semiconductor Limited - President, CEO & Executive Director

* Yu-Cheng Wang

Hua Hong Semiconductor Limited - Executive VP & Secretary of the Board

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Conference Call Participants

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* Randy Abrams

Crédit Suisse AG, Research Division - MD and Head of Taiwan Research in the Equity Research Department

* Sunny Lin

UBS Investment Bank, Research Division - Director & Associate Analyst

* Szeho Ng

China Renaissance Securities (US) Inc., Research Division - MD

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by, and welcome to Hua Hong Semiconductor Second Quarter 2019 Earnings Conference Call. Today's call is hosted by Mr. Junjun Tang, President and Executive Director; and Daniel Wang, Executive Vice President and Chief Financial Officer. (Operator Instructions)

The earnings press release and second quarter 2019 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.

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Yu-Cheng Wang, Hua Hong Semiconductor Limited - Executive VP & Secretary of the Board [2]

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Good afternoon, everyone. Thank you all for joining our second quarter 2019 earnings conference. Today, we'll first have Mr. Junjun Tang, our Executive Director and President, to make some remarks on our second quarter performance. President Tang will address in Chinese and then we'll have [Cathy Chen], our IR Head, to translate in English. After that, I will highlight our financial performance and give guidance for the next quarter. This will be followed by our question-and-answer session.

I'll now turn the call over to our Executive Director and President, Mr. Junjun Tang.

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Junjun Tang, Hua Hong Semiconductor Limited - President, CEO & Executive Director [3]

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[Interpreted] Good afternoon, everyone. Thank you for joining our earnings call. Despite a prolonged global slowdown in the semiconductor industry, Hua Hong Semiconductor continue to make strides in our efforts to become a stronger and better company. Our second quarter revenue of $230 million was at the same level as a year ago, but a 4.2% increase over Q1 2019.

Here are some highlights. Power discrete continued to show tremendous strength and demand increased for all products, in particular for super junction, IGBT and the general MOSFET. We expect growth for discrete to continue into the future. Additionally, revenue for analog and power management IC was up nearly 41% quarter-over-quarter, primarily due to strong demand for those products in China, North America and the rest of Asia.

Gross margin for the second quarter was 31%, 2.6 percentage points lower than Q2 2018 and 1.2 percentage points lower than Q1 2019, primarily due to increased depreciation expenses, partially offset by increased capacity utilization. Net profit margin was an impressive 21.7%, 1.7 percentage points over Q2 2018 and 0.6 percentage points above Q1 2019.

As I said in our last earnings call, we continue to be positive about the overall semiconductor industry. Although we are concurrently dealing with many challenges including markets, technology, customers and a new 12-inch fab that will soon go live, our hard work has paid off. With our team's effort and tremendous support from our customers, our overall capacity utilization has now risen back to 90% and above. We're very confident that the second half of 2019 will be even stronger than the first half.

The 300-millimeter project is moving according to plan. We have completed construction of the building and clean room. At this time, most of the equipment and tools required for the first 10,000 capacity have been moved in and are currently undergoing installation and testing. Our Wuxi fab will begin risk production of 300-millimeter wafers in Q4 2019. Our engineering team is working closely with our customers on a number of tape-outs, which will be part of the initial production ramp-up. We're looking forward to this moment with great anticipation.

Now I would like to hand the call over to our CFO, Mr. Daniel Wang for the financials.

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Yu-Cheng Wang, Hua Hong Semiconductor Limited - Executive VP & Secretary of the Board [4]

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Thank you, Mr. Tang, for the great comments. Now let me begin with a summary of our financial performance for the second quarter, followed by our revenue and margin for the third quarter 2019. And then we will move onto the question and answer session.

First, let me summarize financial performance as of the second quarter. Revenue was $230 million, flat to the prior year but 4.2% above Q1 2019. Cost of sales was $158.6 million, 3.9% above Q2 2018, primarily due to increased depreciation expenses and the unit cost of raw wafers; and a 5.9% above Q1 2019, largely due to increased wafer shipments. Gross margin was 31%, 2.6 percentage points below Q2 2018, mainly due to lower capacity utilization and increased depreciation expenses; and 1.2 percentage points lower than Q1 2019, primarily due to increased depreciation expenses and change in product mix, partially offset by improved capacity utilization.

Operating expenses were $35.4 million, 3.9% above Q2 2018, largely due to increased labor expenses, partially offset by an impairment provision in the second quarter 2018 and 11.4% higher than Q1 2019, primarily due to increased labor expenses. Other income net was $24.6 million, 53.1%, up year-over-year primarily due to increased, one, foreign exchange gain; two, fair value gain on financial assets at a fair value through profit or loss; and three, interest income, partially offset by decreased share of profit from an associate. And 351.1% up quarter-over-quarter, primarily due to foreign exchange gain after loss in the previous period; and two, increased fair value gains on financial assets at a fair through profit or loss.

Income tax expenses was $10.8 million, 19.5% lower than Q2 2018 due to decreased taxable profit. Profit for the period was $49.9 million, 8.7% over Q2 2018 and 7% above Q1 2019. Net profit margin was 21.7%, 1.7 percentage points above Q2 2018 and 0.6 percentage points over Q1 2019. Basic earnings per share was $0.034, $0.01 lower than Q2 2018, and $0.003 lower than Q1 2019. Annualized ROE was 8%.

Now let me provide you with more details on our revenue from Q2 2019. From geographical perspective, revenue from China was $127.3 million, contributing 55.4% of our total revenue and a decrease of 5.3% compared to Q2 2018, chiefly due to decreased demand for smart card ICs, partially offset by increased demand for super junction products.

Revenue from the United States was $42 million, an increase of 5.6% compared to Q2 2018, mainly driven by increased demand for general MOSFET products. Revenue from Asia was $28 million, a decrease of 3.4% compared to Q2 2018, primarily due to decreased demand for MCU and logic products, partially offset by increased demand for super junction and general MOSFET products.

Revenue from Europe was $18.2 million, an increase of 10.3% compared to Q2 2018, primarily driven by increased demand for general MOSFET products. Revenue from Japan was $14.4 million, an increase of 43.9% compared to Q2 2018, primarily driven by increased demand for MCU and logic products.

With respect to technology platform, revenue from embedded non-volatile memory was $79.6 million, a decrease of 10.2% compared to Q2 2018, primarily due to decreased demand for smart card ICs, partially offset by increased demand for MCU products.

Revenue from discrete was $92.5 million, an increase of 21.7% compared to Q2 2018, mainly driven by increased demand for super junction and general MOSFET products.

Revenue from analog and power management IC was $33.4 million, a decrease of 11% compared to Q2 2018, mainly due to decreased demand for LED lighting, other power management IC and analog products. Revenue from logic and RF was $21.6 million, flat compared to Q2 2018.

Revenue from stand-alone non-volatile memory was $2.7 million, a decrease of 50.1% (sic) [55.1%] compared to Q2 2018, primarily due to decreased demand for flash and EEPROM products.

Now let us move to the balance sheet, cash and cash equivalents decreased to $834.7 million on June 30, 2019, compared to $1.155 billion on March 31, 2019. Restrict and time deposits increased from $800,000 on March 31, 2019, to $14.7 million on June 30, 2019, primarily due to $13.9 million restrict deposits for the portion of dividends not paid yet on June 30, 2019. Other current assets increased from $27.1 million on March 31, 2019, to $76.4 million on June 30, 2019, primarily due to advanced payments to suppliers and an increased VAT deductible tax.

Property, plants and equipment increased from $853.8 million as of March 31, 2019, to $1.037 billion as of June 30, 2019. Other noncurrent assets increased from $299.9 million on March 31, 2019, to $363.2 million on June 30, 2019, primarily due to advanced payments for capital expenditures.

Total assets increased from $3.524 (sic) [$3.521] billion on March 31, 2019 to $3.5449 billion on June 30, 2019. Our total bank borrowings decreased from $31.2 million on March 31, 2019, to $28.4 million on June 30, 2019, primarily due to repayments of bank borrowings.

Let's now take a look at the cash flow statement. Net cash flows generated from operating activities were $20.7 million, down by 60.2% year-over-year primarily due to increased payments of VAT deductibles -- the VAT-deductible tax. Capital expenditures were $223.1 million in Q2 2019, including $182.4 million for Hua Hong Wuxi and $40.7 million for HHGrace.

Other cash flow used in investing activities were $57.7 million, including $63.2 million of the investment in financial assets at fair value through profit or loss, partially offset by $5.5 million of interest income.

Net cash flows used in financing activities were $53 million, including $51 million of the dividend payment; $2.2 million of repayments of bank borrowings; $200,000 of lease payments; $100,000 payment of interest expenses, partially offset by $500,000 proceeds from issue of shares.

Finally, let me give you a very top level outlook for the third quarter 2019. We expect revenue to be approximately $238 million and the gross margin to be approximately 31%.

This concludes my financial remarks. Now I would like to open the floor for question and answer. Operators -- Operator, please help. Thank you.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We have the first question, comes from the line of Randy Abrams from Crédit Suisse.

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Randy Abrams, Crédit Suisse AG, Research Division - MD and Head of Taiwan Research in the Equity Research Department [2]

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Yes, wanted to ask the first question on the outlook for third quarter for the $238 million. Could you maybe talk about the growth areas, if you think from the similar areas that have been driving the business with the discrete, MCU and recovery from the analog? Or if you expect some recovery from the embedded flash and smart cards?

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Yu-Cheng Wang, Hua Hong Semiconductor Limited - Executive VP & Secretary of the Board [3]

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Randy, I think we had a very strong quarter. In my view Q2, I think in terms of the revenue, I think not only we hit the target, it has been a strong quarter for us. I think in terms of growth, I think we're probably almost one of the top most -- one of the top companies, okay. First, let me just say that.

In terms of Q3, I think some of the strong areas will be the MCU, MCU would definitely recover, okay. I think Q2 has been a slow quarter for MCU, but the MCU was definitely a strong driver for Q3. I think discrete will continue to grow. Super junction, I see super junction, IGBT, SGT and the general MOSFET, okay. When I say SGT, it's shielded gate trench, MOSFET. So we see strong growth for that -- for these areas as well, okay. I think smart cards is going to be -- probably is going to be weak for Q3. But the increase were mostly coming from MCU and discrete.

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Randy Abrams, Crédit Suisse AG, Research Division - MD and Head of Taiwan Research in the Equity Research Department [4]

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Okay. And maybe to follow-up on the new fab, I think we've originally targeted to be the more advanced smart card MCU. I think now, like since we're going through the slowdown, as you start up the new fab, would it still be those areas? Are you starting to consider a different product mix for the new capacity?

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Yu-Cheng Wang, Hua Hong Semiconductor Limited - Executive VP & Secretary of the Board [5]

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Initially, the new capacity will still be for the SIM cards and bank card ICs, okay. So definitely, the reason we have not been taking that much demand from bank cards and SIM cards because they're no most desirable in terms of price. But I think the 12-inch fab will open the opportunity for both the design house as well as for the foundry. I think by moving them to the next technology nodes, for example, 90-nanometer or 55-nanometer, in fact, it's going to be -- have better efficiencies. We're going to have more values on the wafer.

So I think we definitely yes, the question is yes, it would still be -- the initial would be for small card ICs, in particular SIM cards and bank cards, okay. But eventually, yes, we also plan to have the new fab. We also have a plan for, for example, discretes as well.

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Randy Abrams, Crédit Suisse AG, Research Division - MD and Head of Taiwan Research in the Equity Research Department [6]

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Okay. So the new fab is for discrete. So if -- I guess the ASP is usually lower on discrete, so if you do discretes, I guess, maybe it's a 2-part question, but how you see the profitability, if discretes were to go in. And from the new fab initially, because you'll get some offsets for some grants to support the initial ramp-up from a corporate gross margin as we go into next year, is it kind of the target to kind of -- or reasonable to kind of keep these like above 30% range? Or is it realistic also to have a bit of dilution during the initial phase?

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Yu-Cheng Wang, Hua Hong Semiconductor Limited - Executive VP & Secretary of the Board [7]

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Well, I don't expect the depreciation expense impact will be huge initially. I mean especially this year, okay. We're going to -- we definitely, we're going to do is make sure it'd be minimized, okay. But the ramp-up will start in Q4, okay. We will have some depreciation expenses. It's not going to be much, it'd be minimal. And initially, it would be just trial production basically. But we still plan to have some revenue from the Wuxi fab, that is our target. And we will make sure we're going to have some revenue. We're going to have some shipment from that fab this year.

Once it starts it's not going to stop. But in terms of the depreciation expense, it will be minimized. So I don't think it will have major impact on the gross margin.

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Randy Abrams, Crédit Suisse AG, Research Division - MD and Head of Taiwan Research in the Equity Research Department [8]

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Okay. I guess I asked to get more -- and just into next year, like as you start to bring on more depreciation, but you'll also be bringing up more output. So if you can keep the 10,000 reasonably utilized or ramp that, like if you see kind of still ability to achieve the type of margins or at least close to those margins above 30%.

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Yu-Cheng Wang, Hua Hong Semiconductor Limited - Executive VP & Secretary of the Board [9]

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Well, I -- the plan is we're going to have 10,000 this year. We will immediately start to procure equipment for the next phase, which is mostly going to be for power discrete because they have huge demand. We have a huge demand for power discrete, in particular IGBT and super junction. You have to realize that discrete actually has -- absolutely has the best margin at this point, okay. The -- overall, their ASP per wafer is lower than for example, MCUs and smart cards, but they also have less layers, okay. But once you get into the high end, the IGBT and super -- you have to realize, I mean nowadays for the discrete, we're running more than 40% gross margin on 8-inch fab. So yes, there will be some depreciation.

The depreciation for the next 2 years, we said earlier, are going to be very, very critical for us, okay. It's mostly going to be -- we have to reach the breakeven point. That is going to happen the next 2 years. So whatever capacity we're going to build, we have to make sure we're going to fill it right away, okay. We don't expect -- or we have -- we still have a strong demand, in particular, the discrete, and we can fill more the smart cards. And we also try to get into the MCU segment as well in the other regions.

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Randy Abrams, Crédit Suisse AG, Research Division - MD and Head of Taiwan Research in the Equity Research Department [10]

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Okay. And so last question, I just wanted to ask on -- for this year, if you still think target to grow for 2019? And the second part is just for the OpEx, if you can cover the new fab with the similar OpEx base? Or we should expect some increase in the OpEx as well to bring up the new fab?

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Yu-Cheng Wang, Hua Hong Semiconductor Limited - Executive VP & Secretary of the Board [11]

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Well, as far as the growth for 2019, we -- Mr. Tang just said earlier, we're going to have a better second half -- we expect we'll have a better second half than the first half. I mean our number has already shown that because, I mean our first half was virtually $450.8 million, okay. So our Q3 definitely is going to be better than Q2. We expect we're going to have a stronger second half. We would like to see some growth for this year compared to a year ago.

Overall, this is not being a very good environment. I think the semiconductor industry going -- went through a slowdown. And as Mr. Tang said earlier, our utilization rate has already gone beyond 90% point overall, okay. And we want to continue to move that number up, hopefully get to at a full level, okay. But it's not going to be too far from that. So we expect we're going to fill the fab for the next 2 quarters, we do everything we can to make sure that the utilization is up. And we did a -- hopefully, so that gross margin would be better.

And the second question is about the depreciation expenses...

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Randy Abrams, Crédit Suisse AG, Research Division - MD and Head of Taiwan Research in the Equity Research Department [12]

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Operating expense. The operating expense.

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Yu-Cheng Wang, Hua Hong Semiconductor Limited - Executive VP & Secretary of the Board [13]

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Yes. Well, see the operating expenses will go slight -- go up slightly, in particular for Wuxi. But Wuxi, I think for the year, we're not going to have -- overall, I think we're getting close to a breakeven point for Wuxi. The operating expenses will slightly go up because of Wuxi, because we have additional personnel. But overall, I think Wuxi will, overall, close to breakeven. I mean at the P&L level. If it's anything, there would be a small negative number for the profit and loss at the net profit -- I'm sorry, at the net profit level. And Wuxi is also generating a lot of other income because of the -- through the investment that we made through the -- by investing in financial products.

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Operator [14]

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

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Szeho Ng, China Renaissance Securities (US) Inc., Research Division - MD [15]

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Daniel, 2 questions from my side. The first one, also regarding the JV fab. I think in the recognition measurement, the fab would be starting risk production into the core. So when should we expect the revenue contribution? Is it in the same quarter you mentioned earlier on the call?

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Yu-Cheng Wang, Hua Hong Semiconductor Limited - Executive VP & Secretary of the Board [16]

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Yes. Yes, we expect we're going to have some revenue from the Wuxi fab this year. We're -- we'll have some shipments. Internally, we have a target, and that is a hard target we set in the beginning of the year, and we want make sure we deliver. And there's demand for it. Right now, there are about 5 products that is going through trial -- let's say trial production.

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Szeho Ng, China Renaissance Securities (US) Inc., Research Division - MD [17]

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Okay, good. And then when I look at the 8-inch install capacity, it was kind of flat in Q2. Should we expect some capacity still towards the end of the year in your 8-inch fab?

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Yu-Cheng Wang, Hua Hong Semiconductor Limited - Executive VP & Secretary of the Board [18]

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Yes. Yes. In fact -- you know what, I will let Mr. Tang answer that question, that answers definitely positive.

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Junjun Tang, Hua Hong Semiconductor Limited - President, CEO & Executive Director [19]

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[Interpreted] We have moved the 3 scanners in June and completed almost 97% tools for the first stage. And for the overall process tools, we almost complete over 30%. So the 12-inch fab in Wuxi is moving very fast according to our previous plan.

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Yu-Cheng Wang, Hua Hong Semiconductor Limited - Executive VP & Secretary of the Board [20]

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Szeho, you have more questions?

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Szeho Ng, China Renaissance Securities (US) Inc., Research Division - MD [21]

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Yes. And the last one from my side. Yes, when I look at the nonoperating line and the fair value gain on financial exits, seems to be running at a very high level. So just wanted to get your comment on how we should model that line going forward?

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Yu-Cheng Wang, Hua Hong Semiconductor Limited - Executive VP & Secretary of the Board [22]

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Well, for the equity money we received from the investors, we actually put that money into a secured financial products in the Chinese banks, okay. I mean so for the year, I mean we're looking at close to $30 million, close to $40 million overall. Just the gain from these investment as well as the interest income. I think the interest income is probably around $10 million to $15 million. I think the gain from this financial investment in the financial products, it is about close to $40 million, okay. So I mean but this money will be used in the next 6 to 12 months, it did gradually come down, okay. But at this point, we still have over $1 billion basically. The deposit either in -- either deposit in a U.S. dollar comp or to invest in some secured financial products. The [deals] -- I mean the interest rate, it is about -- we're talking about close to 4%, so which is a very good investment.

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Szeho Ng, China Renaissance Securities (US) Inc., Research Division - MD [23]

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Right. I know. Yes. But how about the fair value gain, would that be unwind when you exit those financial products?

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Yu-Cheng Wang, Hua Hong Semiconductor Limited - Executive VP & Secretary of the Board [24]

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No.

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Operator [25]

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The next question comes from the line of Sunny Lin from UBS.

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Sunny Lin, UBS Investment Bank, Research Division - Director & Associate Analyst [26]

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Yes, so I have a few questions. So number one is on the inventories. I think in this earnings season, you appear in Taiwan and also a few 8-inch IDMs in Europe are all guiding a slower base by inventory digestion for 8-inch, especially in automotive, industrial related. So I'm just wondering, what's your view on the inventory level for your customers versus seasonal as of Q2? And when it will be returned to normal? And specifically, what kind of products are with higher inventory?

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Yu-Cheng Wang, Hua Hong Semiconductor Limited - Executive VP & Secretary of the Board [27]

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Sunny, honestly, I mean this is the same question we got from last earnings call, basically, other than -- a few things, for example, SIM cards and bank cards, okay, we see some inventories before. Maybe there's still some inventories now. I mean most of our other products do not have -- we don't see any inventories, okay. So the SIM cards and the bank cards, yes, okay. But other than that, our customers are -- I think their inventory is pretty normal.

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Sunny Lin, UBS Investment Bank, Research Division - Director & Associate Analyst [28]

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I see. So my second question is regarding competition for power discrete. I think there's more players investing into 8-inch power discrete, given the strong outlook for next few years, including foundries in Taiwan and also Korea. So I wonder, within Hua Hong's power discrete business, what's your [sales boost] between IDM and fabless? And how do you see the intensifying competition impact on your outlook for next, maybe 1 to 2 years?

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Yu-Cheng Wang, Hua Hong Semiconductor Limited - Executive VP & Secretary of the Board [29]

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We're very confident with the power discrete. We have been doing this for so many years, where, I mean, up to this point, we're probably one of the largest foundry for power discrete. We start with the general, the universal MOSFET, which is the low voltage, went from 0 to 60-volt. And then we've been aggressively going after the IGBT and super junction for the past 3, 4 years. And we have gained very good market.

In particular, we're gaining basically a lot of winning a lot of design houses, okay. They're basically replacing a lot of the imports, okay. And Mr. Tang has already said, we have a plan for discrete, for our 12-inch fab, which is going to be pretty much the high end ones, for example, the IGBT and super junction, okay. So we're very much ahead in China, amongst our peers, okay. I think globally, yes, there are some top players. But I think we're pretty confident we'll continue to gain market share. And I think we'll continue to move into more advanced discrete. That is something we would do, in particular for automotive, for industrial. I mean industrial, automotive has become the second largest market now other than consumer electronics because of power discrete. I mean we understand this a very attractive area. There are a lot of -- peers are trying to -- who trying to get into that area, but you know what, we're ahead of them. We'll continue to speed ahead of -- we continue our effort in R&D. And that is something we're going to do.

I'm going to pass on to Mr. Tang. I think he's been actually spending a lot of time on that in the area recently because of the 12-inch fab.

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Junjun Tang, Hua Hong Semiconductor Limited - President, CEO & Executive Director [30]

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[Interpreted] We're putting much results and many resources into the new technology development. So this could be more super junction and IGBT. We also do many new technology developments in the 2-inch fab and we expect there will be a big growth in the second half of 2020. And we also communicate a lot with our domestic customers and Japan customers and the European customers.

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Sunny Lin, UBS Investment Bank, Research Division - Director & Associate Analyst [31]

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I see. That's very helpful. So I just want to clarify, so you said for your second phase expansion for your 12-inch fab, it will be for high-end MOSFET. And I think my understanding is that for power discrete capacity on a comparable basis should be higher than like the normal MCU product or the normal logic product because power has a fewer mask. So let's say, if your Wuxi fab has 40,000 plant capacity, if now we are bringing in some power discrete product, what might be the total capacity?

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Junjun Tang, Hua Hong Semiconductor Limited - President, CEO & Executive Director [32]

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[Interpreted] Our Wuxi fab's development is basically paid (inaudible) effect. First is IC and the second is power. Still, the marketing team and the TD team are working very closely on those areas. And we are very confident there will be good a result.

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Yu-Cheng Wang, Hua Hong Semiconductor Limited - Executive VP & Secretary of the Board [33]

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Sunny, I think -- yes, I mean you're absolutely right. I mean you can basically have 10,000 capacity of MCU, but literally, you can potentially build close to 20,000, 30,000 of discrete. That is correct. The equipment setup might be a little bit different. But in terms of the investment, yes, with 10,000, the regular MCU investment, you can potentially build 20,000, 30,000 of power discrete, that is positive.

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Sunny Lin, UBS Investment Bank, Research Division - Director & Associate Analyst [34]

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So at this point, do we have initial allocation between like MCU and power for this new fab?

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Yu-Cheng Wang, Hua Hong Semiconductor Limited - Executive VP & Secretary of the Board [35]

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We're going to be doing maybe half and half. Initially, we're talking about 40,000. It could be eventually be 20,000 of ICs. And then the other 20,000 could be equivalent to 60,000 of -- equivalent of 60,000 for power discrete.

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Operator [36]

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We have the next question come from the line of [Andrew Liu, Senior Lend Securities].

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Unidentified Analyst, [37]

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Mr. Tang and Daniel, 2 questions from me. For this year, is that CapEx roughly is about $700 million to $800 million?

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Yu-Cheng Wang, Hua Hong Semiconductor Limited - Executive VP & Secretary of the Board [38]

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Yes, that is positive. It's the -- for the Wuxi fab -- I mean, for our Wuxi fab, it's going to be roughly that the PR and PO is about $700 million to $800 million. This is a year for pretty high investment for Wuxi. And then for our Shanghai fab, it's going to be about $100 million -- the most it would be $150 million. Most of that capacity, the 6,000 to 8,000 wafer capacity is going to come out in the next 2 quarters, in Q3 and Q4 for our Fab 3, for the 8-inch business for power discrete.

But yes, Wuxi, we're going to have, as I said, I think that the first 10,000 is all done. We're moving to the next phase, which is going to be mostly for the power discrete.

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Unidentified Analyst, [39]

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Yes. But based on my calculation, your cash flow for this year -- cash inflow, roughly about $300 million to $400 million. So that's $300 million at least, where are the money coming from?

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Yu-Cheng Wang, Hua Hong Semiconductor Limited - Executive VP & Secretary of the Board [40]

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For the investment?

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Unidentified Analyst, [41]

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Yes. The investment, the cash outflow. The cash inflow, we calculate roughly about $300 million, $400 million -- $300 million lower than your CapEx.

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Yu-Cheng Wang, Hua Hong Semiconductor Limited - Executive VP & Secretary of the Board [42]

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Well, Andrew, for the Wuxi fab, I think if you're familiar with our Wuxi financing structure, it is $2.5 billion investment. Let me say that again, it's $2.5 billion investment, $1.8 billion is on the equity, okay, and then $700 million is going to be a loan. We're still spending money from that equity money from the 3 investors, which is us, we own 51%; the IC fund, they own 29%; and the local government, they own 20%. So all of us together, we contribute $1.8 billion. We own 51% of that, okay. And then the Wuxi government owns 20% and then the IC fund would be 29%. So it's a -- this is -- we have gotten all that money, the money is in the bank, in our bank accounts, and we still haven't spent all of that money. Only a small portion of that. Most of the equity money has been invested in some bank products, secured bank products.

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Unidentified Analyst, [43]

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Second question I have is the depreciation cost. For the last -- in the last conference call, you mentioned the depreciation cost in Q4, while -- jumped to above USD 50 million. But in earlier, you say the depreciation cost in Q4 might not be increased that much. So you say, you try to minimize. So I want to understand, is that changed?

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Yu-Cheng Wang, Hua Hong Semiconductor Limited - Executive VP & Secretary of the Board [44]

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Yes. I mean look, overall, okay, as I said, the depreciation expenses for this year, for the -- I expect it's going to be for the overall -- for the 8-inch fab, it's going to be overall around -- the depreciation, it is about $120 million -- I mean it's going to be less than $130 million, okay. The -- this is the 8-inch fab.

And then the Wuxi -- I mean the new fab, the 12-inch fab, Wuxi fab, yes, there'll be some depreciation expenses, okay. But it'd be very small. It would be just land and building, okay. Maybe just a small portion of the equipment, very small portion, okay. So overall, the depreciation expenses for Wuxi is going to be maybe around $10 million to $15 million, okay, overall.

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Unidentified Analyst, [45]

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Yes. We have about $30-something million in the first quarter as a depreciation. Second quarter $30-something million, $33 million, $32 million. In Q3, we are still certifying that it's roughly about $40 million, $50 million in Q4.

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Yu-Cheng Wang, Hua Hong Semiconductor Limited - Executive VP & Secretary of the Board [46]

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For -- I think for Q3, it will be less than that. It's going to be running at the same level as Q2. Q4, yes, we are...

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Unidentified Analyst, [47]

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Q3 would be a similar number like Q2?

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Yu-Cheng Wang, Hua Hong Semiconductor Limited - Executive VP & Secretary of the Board [48]

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Yes. Yes. Yes, that's right.

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Unidentified Analyst, [49]

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So that's roughly about $100 million. Then you have a $130 million plus, $145 million something.

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Yu-Cheng Wang, Hua Hong Semiconductor Limited - Executive VP & Secretary of the Board [50]

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That would be -- yes, that's...

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Unidentified Analyst, [51]

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So Q4 is about $45 million.

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Yu-Cheng Wang, Hua Hong Semiconductor Limited - Executive VP & Secretary of the Board [52]

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Yes. That would be $140 million to $145 million, that would be the good -- that would be a good estimate. Yes, but you know what...

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Unidentified Analyst, [53]

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That's my final question, yes.

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Yu-Cheng Wang, Hua Hong Semiconductor Limited - Executive VP & Secretary of the Board [54]

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But we're very careful with these depreciation expenses, okay. Depending on the -- basically, initially, it's initially, it's going to be this year, where it'll start in Q4, but it would be mostly land and building, a little bit equipment, okay. But next year, we really have a true ramp up that would be something very -- we have to -- at that point, we expect volume will also start to ramp up.

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Unidentified Analyst, [55]

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And Daniel, if I use the $45 million in Q4, that's roughly taking about 7 -- 8% to 9% on revenue. I'm sorry, 8% to 9% on cost of goods sold. So if we are just putting into that number additional cost, we'll take out about 8% to 9% margin. So as an analyst, should we factor in 8% to 9% margin drop in Q4? That's my question.

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Yu-Cheng Wang, Hua Hong Semiconductor Limited - Executive VP & Secretary of the Board [56]

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I would say, it's not going to be as that much. But there will be some impact starting Q4, and it's going to start some point. We cannot hide the depreciation expenses, okay. But we also expect, starting from Q4, we also -- revenue should also start to go up as well. Because we certainly expect there'll be some revenue in Q4 from that -- we started with the Wuxi fab, okay. You have to realize the 12-inch fab for us, it's just going to be ramp-up. We're now going to have had that fab as R&D fab. We're going to start -- starting from Q4, we're going to just make sure whatever capacity we're going to go, we're going to start using, okay. So it is much better scenario than any of the other 12-inch fabs that you have seen in the past. But that is the thing we have to do.

I mean in the next 2 years...

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Unidentified Analyst, [57]

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As analysts, how do we value -- how do we estimate the Q4 gross margin will be from Q3, 31%? Well, I think you will get is about 28%. Do you think that number is a reasonable or reachable? Or it is too high? Gross margin.

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Yu-Cheng Wang, Hua Hong Semiconductor Limited - Executive VP & Secretary of the Board [58]

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For this year?

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Unidentified Analyst, [59]

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Yes. Given the consensus for Q4 is 28%.

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Yu-Cheng Wang, Hua Hong Semiconductor Limited - Executive VP & Secretary of the Board [60]

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Well, I think you'll have a better picture when we -- at our next conference earnings call. I mean I think it's a good number to assume, okay. I think we still want to have a good gross margin, solid gross margin for the year, okay. But the reality is, we're going to have a new fab. Next 2 years, we're going to have -- we would be hit with some depreciation expenses, but it's possible we have to grow also. As long as we deliver -- as long as it's in your model, we still want to make sure we have good profits for the next 2 years.

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Operator [61]

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Ladies and gentlemen, that's all for the time we have for questions. I would now hand back to Mr. Daniel Wang for closing remarks.

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Yu-Cheng Wang, Hua Hong Semiconductor Limited - Executive VP & Secretary of the Board [62]

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Well, again, thank you all for joining us, everyone. We hope you will all join us again next quarter. I personally look forward to meeting you and again, in the investor meetings and our NDRs throughout the quarter. Thank you, and we continue to wish you enjoy a wonderful summer.

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Operator [63]

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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.]