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Edited Transcript of 2018.HK earnings conference call or presentation 23-Aug-19 8:15am GMT

Half Year 2019 AAC Technologies Holdings Inc Earnings Call (Chinese, English)

Shenzhen Aug 27, 2019 (Thomson StreetEvents) -- Edited Transcript of AAC Technologies Holdings Inc earnings conference call or presentation Friday, August 23, 2019 at 8:15:00am GMT

TEXT version of Transcript

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Corporate Participants

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* Joe Kuen Mok

AAC Technologies Holdings Inc. - Executive Director

* Zhengmin Pan

AAC Technologies Holdings Inc. - Co-Founder, CEO & Executive Director

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Conference Call Participants

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* Arthur Lai

Citigroup Inc, Research Division - VP and Analyst

* Leping Huang

China International Capital Corporation Limited, Research Division - Analyst

* Man Nga Chui

DBS Vickers Research - Analyst

* Yunchen Tsai

Morgan Stanley, Research Division - Equity Analyst

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Presentation

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Unidentified Company Representative, [1]

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Good afternoon. Welcome to our 2019 interim results broadcast and conference call. My name is [George Kwok], and I'm the Head of Investor Relations at AAC. I'm glad to have our senior management team joining this call today with Mr. Benjamin Pan, our Chief Executive Officer; and Mr. Richard Mok, our Managing Director. Before we start, we would like to remind you that the copies of our results announcement and presentation are all available on our website.

We'd like to draw your attention to the disclaimer on the last page of this presentation slide as well. Some information we discuss today might contain forward-looking statements.

I will now present the 2019 interim results. The revenue for the first half this year has dropped 10% year-on-year to CNY 7.6 billion. It was a challenging period with reduced global smartphone shipments. However, if we focus on second quarter revenue, it has shown a sequential improvement with 1% year-on-year increase and that has mitigated some of the decline in the first quarter. As you can see from the pie chart, acoustics, electromagnetic drives and precision mechanics remains our key revenue contributors, and optics also started to contribute more revenue as well. Gross profit margin decreased by 9 percentage points from last year to now 27.5% as some of our new design solutions were still in their early cycles. A key positive of the results is a good progress in business development and R&D for the acoustics business, where our proprietary product SLS has further gained market share in the Android markets. We'll also like to highlight optics as one of our key and strategic growth drivers for this year and onwards with its strong growth potential and economy of scale. We are going to further elaborate on this in the later session. Net profit dropped 57% year-on-year to CNY 770 million mainly due to the reduced gross profit, as just mentioned, and some increase in R&D expenses, mainly on the optics. EPS dropped a little bit less than the net profit drop, reflecting the reduced number of shares after some share buybacks in the last 12 months.

The Board declared an interim dividend of HKD 0.40 per share, which is the same as last year.

We continue to make satisfactory progress on the business development and R&D in the second quarter. For acoustics and for our proprietary product SLS, we have successfully penetrated into the mid-tier Android models.

For optics, the average monthly shipment has doubled year-on-year. We have accelerated the technological development and mass production of WLG lenses. We are proactively developing new imaging lens models and building a new factory in Nanning for these. We also had in R&D center in Finland that focuses on developing innovative optical technologies and new applications.

For electromagnetic drives, the stepper motor module has started mass production and shipment to mainstream Android customer as a new revenue driver for us. We are ready to embrace the 5G era, and we have launched 6 different 5G antenna solutions for mobile phones and base station during the Mobile World Congress in June this year. And as for the patents, we now own close to 4,000 patents, an increase of 18% from year-end last year.

Before we go to the details of each business segment, we would like to draw your attention to our strong balance sheet, which is particularly important when this world is full of uncertainties and volatilities. Our net gearing remained healthy at below 10% for the first half this year. And we have ample gross cash on hand and around half in renminbi and other half in U.S. dollars. Our strong operating cash flow is also more than enough to cover dividend payments and share buybacks. We also emphasized on return to shareholders, and it can by at least 2 ways, which are dividends and share buyback. We have declared an interim dividend of HKD 0.40, which is the same as last year. While we do not have an explicit dividend policy, in the last 5 years, the DPS has been at the 40% of the EPS. In the first half, we have spent around CNY 1.4 billion on paying dividends and buying back shares.

Despite the uncertainties around the world and ups and downs around the global smartphone cycle, we are dedicated to invest for our future growth. Our R&D centers are all over the world, including China, Finland, Denmark, Singapore, Korea, Japan and the U.S. The R&D expenses has gone up 15% year-on-year and the increase is mainly on the optics, which is in line with our strategy to make it our key growth driver for the future. The other segments' R&D expenses has dropped in line with the revenue trend. R&D expenses in first half accounts for around 10% of the revenue and CapEx in first half accounts for around 17% of revenue, although we tend to look at both of these on a full year basis.

So this slide just quickly shows that we have rather diversified manufacturing bases all over Asia Pacific.

For the optics, we have reinforced this as our key and strategic growth driver. In fact, we have already become top 3 global supplier in the plastic lens supply chain. Our average monthly shipment in second quarter has already doubled from last year's second quarter. And we target to make it another double by this year-end and the profitability to also improve.

So now we go through a bit more details for each business segment. Okay. So for acoustics, revenue dropped 15% year-on-year to CNY 3.65 billion. Gross margin dropped by 7% percentage points to 30%, so gross profit dropped 32% year-on-year to now CNY 1.1 billion. And the acoustic revenue accounts for 48% of our total revenue. This segment has been affected by the reduced global smartphone shipments and extended cycles for spec upgrades. Having said that, our SLS product platform continued to gain market share in Android smartphones. Overall, we expect a better second half than the first half as we expect an uptrend for both shipment and ASP and potentially the gross margin as well. So for this segment, the revenue accounts for 40% of our total revenue. The revenue dropped 12% year-on-year.

Electromagnetic drive showed a decline and precision mechanics show a significant growth. Even though the revenue for EM drives dropped, the margin has been largely maintained, thanks to our operational efficiency. Precision mechanics has been doing great with revenue increase, but this segment tend to have a lower margin, so the overall margin for this whole segment has dropped. We are positive on our outlook for this segment for second half this year and next year, especially in terms of capacity utilization.

MEMS segment has been doing great during the first half as well. Top line is up 11% year-on-year. And together with margin expansion, gross margin -- gross profit up 34% year-on-year. Both shipment and ASP has been up in the second quarter. We have been working hard on increasing the in-house MEMS dies and digital ASIC chips in our MEMS microphone so as to improve the margins. We've also broadened the application of our MEMS to new devices such as those in the smart home markets.

We included this slide in the past as we have put tremendous efforts on the sustainability. It's within our core value, we believe we are one of the leaders in -- on this regard, whether it's among the tech companies in Asia or among the major stocks listed in Hong Kong Stock Exchange. So please refer to the bullet points here for what we have done and achieved here, and we will have a full sustainability report to be published soon for fiscal year 2019.

So that's all for my presentation. We will now open the floor for the Q&A session. Thank you.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first questions come from the line of Susanna Chui from DBS.

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Man Nga Chui, DBS Vickers Research - Analyst [2]

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I understand that AAC has planned for the mass production for the hybrid design -- hybrid lens design. So could we understand the mass production is for which client? Is it for the [Russian] model? And how is your expected shipment and ASP for that? And could you disclose if you have any capacity expansion plans for hybrid lens [in Suzhou]?

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Joe Kuen Mok, AAC Technologies Holdings Inc. - Executive Director [3]

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Hi, Susanna, thank you for your questions. As we have said earlier, our hybrid lens strategy comprised of a successful recognition of the capability of a stronger differentiating to what the current plastic lens could deliver. We have received significant interest from all our customers on the capability of hybrid lens. And whereby the important component there is that our mass production were good, satisfactory yields on WLG, wafer-level glass. We are maintaining our plan. I think towards the year-end, we are preparing for a higher-volume mass production, but at the moment, I don't -- I can't -- cannot disclose any kind of clear specifics on shipment numbers or project details. But I believe, hybrid lens is going to be an important trend in delivering higher optical specifications.

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Zhengmin Pan, AAC Technologies Holdings Inc. - Co-Founder, CEO & Executive Director [4]

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(foreign language)

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Joe Kuen Mok, AAC Technologies Holdings Inc. - Executive Director [5]

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In the first half in our Denmark facility, we have already -- have more than 20 molding machine equipment in operations and we have hired -- taken on more than 100 employees, and they are undergoing what we call a training phase. The data that we've been seeing from the facility have proven very clearly the proposition that in terms of the precision and the optical performance that WLG lens can achieve is much, much better than what the plastic lens can offer. Our current interaction or the penetration, the successful penetration in all our Android customers have led to a very clear direction that they are interested in the stronger optical applications that WLG can offer. We believe the optics strategy for AAC will be proven of very high contribution value, significant to our business in the next 3-year period.

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Man Nga Chui, DBS Vickers Research - Analyst [6]

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And I actually have a second question, follow-up question. Felt that the AAC has fixed antenna solution to be launched, and do you have any expected revenue contribution in 2020, which is a big year for 5G, and maybe coming 2 to 3 years. And any target margins you feel can reach the corporate long-term margin, for example, 40%?

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Joe Kuen Mok, AAC Technologies Holdings Inc. - Executive Director [7]

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Susanna, thank you for asking this question. I think there is no change in our expectations on what we can deliver of gross margins for what we call the core technologies solutions that AAC is delivering to the market. In the past, as we have seen that in acoustic and haptics, we have maintained a very high level of gross margins, and we -- and at the current time, there are projects that demonstrate our core competency of still rewarding us with 40% plus gross margins. Hence, there is no reason why we should not believe that, for example, that we described WLG and our unique capability in plastics, that we should not be able to deliver gross margins of about 40% when these business reach their, what we call, full bloom in terms of production, in terms of adoption by the industry, in terms of market customers penetration. I think -- also, I think you mentioned the year 2020. I think as we see more and more change in the design to cope with 5G complex antenna systems designs, I think not only our acoustics and haptics and optics will be able to further contribute to growth of business, but also our precision mechanics business, whereby I think in the first half of this year, we've already seen a lot of our business in the precision mechanics is geared to a much more complicated, what we call, designs in order to cope with the future 5G era. And hence, I think that year 2020 will offer very exciting opportunities for all of these -- our segments; acoustics, haptics, optics, and precision mechanics. And I think including the new interesting and innovative designs for electromagnetic drives, those have all very kind of interesting opportunities.

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Zhengmin Pan, AAC Technologies Holdings Inc. - Co-Founder, CEO & Executive Director [8]

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(foreign language)

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Joe Kuen Mok, AAC Technologies Holdings Inc. - Executive Director [9]

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Benjamin describes further details. I think in our first half, we've seen we have taken the opportunity to prepare for more technological foundation in this period of transition. In the medium term, we believe all of our -- or each of the 4 product lines we have, namely acoustics, haptics, optics and the precision mechanics with antenna capabilities, these 4 product lines each should achieve more than sales revenue of CNY 10 billion each. I think we do not need to elaborate too much on the preparation we have already on the SLS and the various acoustic designs or R&D that we have been leading in. We have no doubt that in the medium term, we would -- these will bring sales revenue of over CNY 10 billion. In haptics, I think in this period, we've already seen Android phones moving on higher specs requirements, but also not only in smartphone. There are different phases of discussions with the new automobile market or the new applications in the automobile market. And within these discussions, we strongly believe that I think in the next 1 to 2 years, we will see our haptics solutions expanding or penetrating into this automobile market. In the medium term, I think we believe that haptics sales revenue or the annual sales haptics revenue has a strong possibility that it will outgrow the highest sales revenue of what we have achieved in the past. And plastic -- in terms of optic lens, I think we discussed briefly in the previous question about WLG. I think we want to reinforce the arguments or the main applications, the 3 main applications that hybrid lens will strongly present a differentiating performance parameter. I think, first of all, the front lens, the front lens design requires specific specs and we believe the hybrid lens can be easily and quickly be designed into that purpose. But more interestingly, I think as we see the main camera as we -- as the user experience demands higher resolution of going up as high as over 100 million mega resolution, those design of the plastic lens seat height have exceeded 8 millimeter already, and whereby in terms -- or approaching 8-millimeter height already, whereby the thickness of smartphone restricted the design of such kind of thick main camera. I think with the design of 1 to 2 pieces of glass lenses in the main camera, we can help to resolve or definitely reduce this height design problem. Finally, the first functionality I think that hybrid lens can deliver definitely will find its way is what we call the under-display camera. The glass lens definitely have a higher transparency index and could work far better than a plastic lens design. The fourth product line, clearly, we talked about. We have invested and accumulated experience in the precision mechanics business. There've been -- I think in the past, there have been talks about metallic -- outphasing of metallic case designs for 5G. We've learned from the market that metallic case designs for 5G is possible. It requires higher precision, and AAC is well positioned to utilize our experience not only on metallic casing but also our years of experience in LDS. And I think this year, we also have experienced very interesting know-how developing in terms of -- in the areas of heat dissipation and coming out with different layers of LCP. Those will help us to formulate and propose very interesting proposition designs for the 5G casing business. But admittedly, I think, in the precision mechanics business, the overall industry return, if we compare to what is highly feasible for the other 3 product lines of well above 40%, I think that clearly in terms of precision mechanics, it may not be as high as the other 3 product lines' gross margins. But nevertheless, the return on assets employed in the precision mechanics should prove to be a high satisfactory return, and is -- there is no reason why we do not expect to grow precision mechanics business, again, to achieve annual sales revenue of over CNY 10 billion.

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Operator [10]

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The next question comes from the line of Leping Huang from CICC.

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Leping Huang, China International Capital Corporation Limited, Research Division - Analyst [11]

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So I have 2 questions. So one question is about the gross margin of your acoustic business. So in your statement, you said you expect margin recovery in the second half. Can you share the reason behind -- is it because of your higher mix of the SLS? Or is it because of stabilization of the competition environment in the U.S. customer? (foreign language)

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Zhengmin Pan, AAC Technologies Holdings Inc. - Co-Founder, CEO & Executive Director [12]

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(foreign language)

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Joe Kuen Mok, AAC Technologies Holdings Inc. - Executive Director [13]

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We are not commenting on the business related to the U.S. customer, but in terms of our penetration in the Android business, I think last year, our -- we have said we estimated our penetration to be around 35%. And I think over the recent periods, gradually, it has gone up to more than 50%. I think by -- throughout this year, we have target -- we aim to take higher penetration to around 70% to demonstrate the widely adoption of a stronger acoustic performance in acoustic. What is important is that we have already prepared an upgraded version to the previous entry version, whereby the vibration or the movement of the diaphragm can double from, for example, roughly 35 to 65. And clearly, that would provide a strengthening -- a very noted user experience upgrade. And I think by the end of this year, there are clear market response or indications that the upgrade of acoustic will continue to next year, and we are confident that AAC is the major technology provider for this upgrade.

And through that, this is the reason why we believe our margins performance will gradually improve.

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Leping Huang, China International Capital Corporation Limited, Research Division - Analyst [14]

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(foreign language)

So the second question is about the optical -- optics business. So if we look at the industry, the largest player is around RMB 10 billion in terms of RMB sales, and that's about 70% gross margin. The number 2 player is around CNY 5 billion sales, and which is around 45% gross margin. So I mean if you look at your company, your revenue is around, I think, if I guess is around CNY 1 billion to CNY 1.5 billion in revenue for this year. So the gross margin seems to be extremely much lower than your peers. So whether it is mainly due to product mix issue or whether it's mainly due to scale issues?

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Zhengmin Pan, AAC Technologies Holdings Inc. - Co-Founder, CEO & Executive Director [15]

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(foreign language)

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Joe Kuen Mok, AAC Technologies Holdings Inc. - Executive Director [16]

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In the first 6 months, we are pleased that our preparation for capacity of 60 million for hybrid lens has been fully laid out. I think going forward, maybe individual process may require a couple of equipment, but other than that, we believe our investment in terms of preparing for 60 million hybrid lens output is all in place. As we have announced, I think by the end of June, we are only shipping out around monthly 30 million. So out of the 60 million capacity, we are shipping out 30 million. And it is a fact that at the moment, there is still some designs which are more of what we call resolution design 4P, which we believe as we improve our shipment volume, the mix should turn into a much more favorable one, whereby 5P plus some 6P should help to improve the performance of the optic business. And all along, we have stressed that we -- our own tooling and our own fixtures continue to play an important part in a continual process of improving our yield, which I think -- which is going to be a very important criteria for us to not only to achieve our industry gross margin standard, but also to outperform our competitor in this regard. We do -- are continuing with our plans of increasing capacity to over 70 million per month, maybe, I think quite early next year. But what is important is that we recognize that all our -- we have successfully penetrated in all our major customers already, whereby it is a known fact that in terms of the cost of optics business, the material play a relatively fixed portion. The important criteria is the mix of project design and our internal yield rate. And we are confident that not only that at the current stage because of the mix of our continued investment in the glass WLG, whereby the R&D expenses will, in a way, impact our operating performance, but it also lays out very important strong basis for us to move on and to include hybrid lens into our portfolio of optic performance business, whereby we do believe our gross margins performance will be improved significantly.

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Operator [17]

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The next question's come from the line of Arthur Lai from Citi.

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Arthur Lai, Citigroup Inc, Research Division - VP and Analyst [18]

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(foreign language)

So let me explain my question in English. How you solved the WLG's molding stability and the mass production [reduction] issue? And that when we can see the cost parity with the whole plastic lens? And then follow-up question is the supply chain. How you do this supply chain for the WLG?. This is my first question.

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Zhengmin Pan, AAC Technologies Holdings Inc. - Co-Founder, CEO & Executive Director [19]

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(foreign language)

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Joe Kuen Mok, AAC Technologies Holdings Inc. - Executive Director [20]

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It's -- I think we discussed about 2 aspects. First of all, how we tackled the stability of molding of glass lenses. I think in some of the other suppliers, the glass lens is molded piece by piece individually. What we have described in our production process for our WLG, at the moment, we are referring to a cycle of life of something like 3000 times before we need to maintain or repair or change the molding equipment or the accessories. We have clear performance road map.

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Zhengmin Pan, AAC Technologies Holdings Inc. - Co-Founder, CEO & Executive Director [21]

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(foreign language)

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Joe Kuen Mok, AAC Technologies Holdings Inc. - Executive Director [22]

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[Slowly]. When we are -- we are clear to work on how to elongate this cycle before we have to repair this molding part, and we saw a very strong possibility of elongating it to 5,000 cycles. So that's one target that we have set ourselves in terms of how we could achieve higher stability for the molding process. But also I think we've discussed the [view] or the process of the 2-inch wafer and how we set our target to come out with higher precision in terms of achieving what we call 0.5 micromillimeters, whereby at the moment we are seeing something like out of 100 pieces, we can see around 50. Again, our internal road map or target or improvement in process, we hope to be able to improve that to out of the 100 output, we will be able to deliver something like 80 pieces, and the precisions can be improved to what we call 0.5 micromillimeters, whereby we're talking about improvement enhancement of 2 parameters, which, at the end of the day, will lead us to better kind of improvement in process and also yield. And that is happening in Denmark and we are setting up a facility in Czechoslovakia to implement this process, where we believe there are the provision of such skilled engineer to help us to achieve that. The second part of the question, I think, relates to the importance for us to recognize not only that the yield capability achieved in plastic lens is a necessity for us to promote hybrid lens, because the hybrid lens make use of the production process in plastic lens as well. So we have to not only focus on the molding stability achievement in WLG but also the overall yield in plastic lens. And I think at this moment, we are already -- I think the priority of the WLG goes towards internal use. We will satisfy our own demand first, but we will also consider providing WLG lens to other module operations as well so as to promote the hybrid lens.

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Arthur Lai, Citigroup Inc, Research Division - VP and Analyst [23]

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(foreign language)

So my final question is the CapEx. Can you break down the CapEx by the main market?

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Joe Kuen Mok, AAC Technologies Holdings Inc. - Executive Director [24]

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Yes. I think earlier on, we discussed a CapEx budget of around CNY 2 billion. I think that has not changed in a material way. Maybe CNY 2.1 billion is what we forecast for the whole of this year. Around -- before, we said around 30% to 35% is related to infrastructure. The remaining 65%-ish, I think half of that will be focused on optics related. And we will divide that mostly -- I think as we have already said, the 60 million plastic lens capacity, the machineries is already ready. So most of that part will be for our WLG setup. So the remaining something around 30% is almost equally divided between the remaining 3 other lines of acoustic, haptics and precision mechanics products.

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Operator [25]

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The next question comes from the line of Yunchen Tsai from Morgan Stanley.

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Yunchen Tsai, Morgan Stanley, Research Division - Equity Analyst [26]

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So my first question is actually regarding what Ben just said. (foreign language)

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Zhengmin Pan, AAC Technologies Holdings Inc. - Co-Founder, CEO & Executive Director [27]

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(foreign language)

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Joe Kuen Mok, AAC Technologies Holdings Inc. - Executive Director [28]

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We believe that the time line for not giving a forecast of definitive sales revenue. But I think this year is 2019. I think we are talking about the year 2022, that varying market conditions and [uncontrollable] kind of development of the various markets, we hope to see these 4 product lines achieving the sales revenue that we discussed. But whether there are opportunities that we can deliver earlier, I think definitely is AAC's interest, and we are prepared to do so. Having said that, in acoustic, we are -- have -- and as announced, we are -- we have some initiatives in other markets other than smartphone, but we believe the penetration or the extension may be slower than what we see for haptics. Whereby in haptics, we are already in talks with customers outside the smartphone applications, for example, in wearables, in smart household devices, and as we discussed earlier on, in automobiles as well. I think 2 propositions for stronger haptics extension into non-smartphone application is clearly that, for example, in these stepper module design, it clearly have a very specific user experience of letting the applicant know that a functionality is on or off. That is a clear, desirable design. The second part of the attraction is a kind of revolving wider kind of angle of 180 or 360 degrees. But the importance is, all these new applications and interesting user experiences, we can deliver these devices or components based on what we already have as general equipment, what we have already invested in and the know-how that AAC is very strong in. There is no -- again, we are very confident that in haptics, such extension of applications would help us to achieve the aforementioned sales annual revenue target. In optics, we've discussed a little bit in this call already, and we also discussed about higher OIS requirement involving SMA. So in optics, we are again very confident. Finally, in the 5G era, our capability in heat dissipation and design of LCP layers, again, I think within the time frame that we discussed, we are working hard to deliver that.

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Zhengmin Pan, AAC Technologies Holdings Inc. - Co-Founder, CEO & Executive Director [29]

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(foreign language)

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Joe Kuen Mok, AAC Technologies Holdings Inc. - Executive Director [30]

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Benjamin firmly wants to mention that our achieved status with SLS at the moment is only a beginning, as we have already discussed about further enhancing not only user experience but technical possibility of pushing a stronger, better sound in all high-end and different applications of the SLS platforms. And that would be a contributing factor for us to deliver the sales revenue that we are aiming.

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Yunchen Tsai, Morgan Stanley, Research Division - Equity Analyst [31]

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So my second question is a bit more detail. It's also a follow-up to the Android acoustic margins. So just comparing the second quarter and the first quarter, is the -- the Android acoustic margin, has it improved? Because overall, I would imagine, in the second quarter, the acoustic Android revenue, it should be -- that should have a larger mix. And also again, I think the SLS mix has increased, but the second quarter acoustic margins still are declining. So I just want to make sure if this part actually has -- I mean the margin has improved in the second quarter. And also in looking into second half, if we can -- if we are anticipating an improvement? Is it due to -- more due to a price -- better pricing, better yield or the higher automation level?

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Joe Kuen Mok, AAC Technologies Holdings Inc. - Executive Director [32]

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I think there are 2 very exciting developments for SLS in the Android market in the second quarter already. I think first of all, as we have said, we already have seen the upgraded version being adopted by a couple of major customers. That's one thing. And there is a slight betterment of ASP in a slight upgraded version. But more importantly, we are seeing some customers already extending SLS adoption to what we call mid-segment-tier phones to extend market share of SLS as well. Through these 2 factors, I think there is a continued trend, not only on ASP, but not only on volume. The overall as, after all, we are very much automation, proprietary production focused. There is no factor that -- in those favorable factors that we should not see an improvement in our profitability and operating margins in SLS. What is more important, is more kind of coming later this year, not only we have an upgraded version, but we have what we call a classic version whereby we briefly talk about the vibration extending to 0.65 movement. And there is a very strong upgrade in the acoustic performance and also a strong upgrade in ASP percentages as well. Of this, we believe we could see achievement of better gross margins.

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Operator [33]

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We have reached the end of our question-and-answer session. I would now like to turn the floor back over to the host today for closing comments.

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Unidentified Company Representative, [34]

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Thank you. In view of the time, we are calling the end. Once again, thank you for joining us in this audio webcast and conference call. If you have further questions, please do not hesitate to contact the IR team contact on the second last page of this presentation slide. Thank you.