Phone continues to decline, while automotive and AR/VR will have high growth (Sunny Optical 22H1 conference call)

On the evening of August 15th, Beijing time, Longbridge Hong Kong Stock Exchange released its 2022 interim report (as of June 2022), with the following main points:

Quarterly core data vs. market expectations (Bloomberg consensus expectations):

1) Revenue end: The revenue for the first half of the year was 16.972 billion yuan, a year-on-year decrease of 14.4%, lower than market expectations (17.619 billion yuan);

2) Gross profit margin: The gross profit margin for the first half of the year was 20.8%, a year-on-year decrease of 4.1 percentage points, in line with market expectations (20.67%);

3) Net profit: The net profit attributable to the mother for the first half of the year was 1.379 billion yuan, a year-on-year decrease of 49.1%, close to the company's previous profit warning threshold (1.344-1.478 billion yuan);

4) $ Sunny Optical Technology.HK business situation: ①Revenue for mobile phone business in the first half of 2022 was 12.756 billion yuan, a year-on-year decrease of 19.5%. (There were 741 million shipments of mobile phone lenses from January to July, down 9.9% year-on-year; the shipment volume of mobile phone modules was 325 million from January to July, a year-on-year decrease of 21.9%);②Revenue from the automobile business in the first half of 2022 was 1.725 billion yuan, a year-on-year increase of 6.9%;③Revenue from the AR / VR business in the first half of 2022 was 660 million yuan, a year-on-year increase of 10.5%.

For detailed financial information, please refer to Dolphin Analyst's comments on the report Poor mobile phones have ruined Sunny's first half of the year.

Based on Sunny Optical's financial report and conference call, the Dolphin Analyst believes that the company's net profit in the first half of the year has fallen by nearly 50%, which is really "miserable". This is mainly because 70%-80% of the company's revenue is concentrated in the mobile phone business. When the mobile phone business is slow, the company's performance directly "collapses." Therefore, the company is also vigorously developing the automobile business and ARVR business to diversify the risk of business concentration, and nearly half of its capital expenditures are invested in the revenue areas that currently account for less than 15%.

Regardless of the industry or performance, the first half of the year was a difficult time for the company. Can the company emerge from adversity in the second half of the year? From July's shipments and company guidance, the company's mobile business will continue to be weak in the second half of the year, while the automobile and ARVR businesses have shown signs of improvement. As the mobile business is still the company's biggest source of performance, the company's performance in the second half of the year will still be dragged down by the weakness in mobile phones.

Some industry situations can also be seen from Sunny Optical's data: 1) Sunny Optical mobile phone business: A year-on-year decrease of nearly 20% in the first five months of 2022** indicates that the inventory of the Android/mobile phone industry is still relatively high, and it will be difficult to see significant improvement in the second half of the year; 2) Sunny Optical vehicle-mounted lenses**: In the first five months of 2022, a year-on-year increase of 20-30%** indicates that the demand in the automobile market is better than that in the mobile phone market, and the low growth in the first half of the year was mainly due to chip shortages, and the return to high growth in the second half of the year indicates that the chip shortage has been eased. 3) Shunyu's ARVR Business: The growth rate will return to over 80% in the second half of 2022, indicating that the release of new ARVR products and the industry promotion in the second half of the year is expected to accelerate.

1) Telephone Meeting Information Summary:

1) 2022 Full-Year Guidance:

① 2022 OPEX Expense Rate Guidance: Approximately 12%; (Guidance was 9% in March this year, now raised. Since the expense rate for the first half of the year was 12.2%, it will be relatively stable in the second half of the year following the guidance).

② 2022 CAPEX Plan: A total of 3 billion RMB will be spent on new businesses, including ARVR, in-car cameras, and LiDAR, amongst others, of which 1 billion RMB will be spent on ARVR business, 0.3 billion RMB will be spent on an expansion of in-car camera production, 0.7 billion RMB will be devoted to the expansion of phone cameras for US customers and technological upgrades, and another 0.5 billion RMB will be spent on infrastructure to prepare new bases in countries such as Vietnam. (This guidance is consistent with that of March this year.)

③ 2022 Gross Margin Guidance: The gross margin for phone lenses will be down compared to last year, within a range of 30-35%; Albeit for in-car lenses, the gross margin for the whole year will be around 40%; The gross margin for phone camera modules will be around 10% for the whole year. Overall, the gross margin will decline with pressure compared to that of 2021. (Taking into account the gross profit margins of optical components at 35.5% and optoelectronic products at 11.6% in the first half of the year, the gross margins for the second half of the year will be similar to those of the first half of the year).

④ Shipment Volume Guidance: The shipment volume of phone lenses for the whole year is expected to drop by about 15% YoY, while the shipment volume of phone camera modules is expected to drop by about 20% YoY, and the shipment volume of in-car lenses is expected to increase by 10-15% YoY. (**Guidance was 5-10%/10-15%/20-30% in March this year, but has now been significantly reduced. Taking the shipment volumes of the previous seven months into account, the shipment volume of phone lenses dropped by 9.9% YoY, the shipment volume of phone camera modules dropped by 21.9% YoY, and the shipment volume of in-car lenses grew by 3.8% YoY, indicating that the shipment volumes for the next five months are expected to decrease by 21.8% YoY for phone lenses, 17% YoY for phone camera modules, and increase by 20-30% YoY for in-car lenses.)

2) Phone Lens Prices: Phone lens prices dropped by about 10%-15% YoY in the first half of the year, slightly less than in the second half of 2021. The ASP in the second half of the year is expected to be relatively stable. The main reason for the decrease in ASP for phone lenses and modules is the decrease in specifications.

3) The Bottom Line of Phone Module Gross Margin: 10-12%.

4) In-car Lenses: The ASP for in-car lenses was stable YoY in the first half of the year, with a slight increase, and will remain flat QoQ in the second half of the year. There is room for further growth in the ASP of in-car lenses. The increase of in-car lenses in the first half of the year was only 0.8%, mainly due to a chip shortage. This shortage is now alleviated, and a growth of around 30% is expected in the second half of the year. 5) ARVR Business: 50% growth has not changed (due to the 11% growth in the first half of the year, it is expected to achieve a growth rate of over 80% in the second half of the year);

2. Telephone Conference Transcript

2.1 Management Report

Guidance

1. 2022 OPEX expense rate guidance: around 12%;
2. 2022 CAPEX Plan: RMB 3 billion will be allocated to new businesses such as ARVR, car camera systems, and LiDAR, of which RMB 1 billion will be allocated to car camera lens production expansion; RMB 700 million will be allocated to mobile phone lenses to prepare for the expansion of US companies and technical upgrades; RMB 500 million will be allocated to camera module infrastructure transformation without production expansion, and RMB 500 million will be allocated to the construction of new bases in Vietnam and other places;
3. 2022 gross margin guidance: The full-year gross margin of mobile phone lenses will decline compared to last year, with a range of 30-35%; the full-year gross margin of car camera lenses will be around 40%; the full-year gross margin of mobile phone camera modules will be around 10%; the overall gross margin will decline compared to 2021, putting some pressure.
4. Shipment guidance: The full-year shipment volume of mobile phone lenses will decrease by around 15% year-on-year, and the full-year shipment volume of mobile phone camera modules will decrease by around 20% year-on-year, while the full-year shipment volume of car camera lenses will increase by 10-15% year-on-year.

Outlook

1. The car camera module hopes to achieve a sales revenue of RMB 1 billion for the whole year through efforts.
2. LiDAR has obtained three new contracts this year, accumulating a total of 30 contracts.
3. AR-HUD has obtained 12 new contracts in the first half of the year, accumulating a total of 20 contracts.

2.2 Analyst Q&A

Q: Machine equipment prepaid expenses on the balance sheet increased by 80% in the first half of the year. Is this related to North American customers? How will the trend of this expense change in the future? When will it peak?

A: Prepaid expenses include the money we pay to North American customers, but there are other expenses as well. It is not only North American customers who are expanding production capacity, but also preparing for other imaging businesses. The second question is difficult to answer because it depends entirely on the development of our business and may continue to increase. So I just introduced some emerging optical business, including AR and VR. We will have an increase in production capacity, so prepaid expenses may continue to increase.

Q: What is the current production capacity of North American customers? Just now you mentioned the development of the Android mobile phone business. I would like to ask about the development of North American customers in August and September?

A: We have signed a confidentiality agreement with the customer and cannot give you specific production capacity figures. But what we can tell you is that this year, we have entered the second year of mass production, and we have more projects underway. Therefore, compared with last year, the shipment volume will increase significantly.

Q: The guidance mentioned that the shipment volume of lenses will decrease by 15%, but it only decreased by 9% in the first half of the year. Does this mean that the shipment volume will further deteriorate in the second half of the year? Camera modules have not seen a significant decrease in your market share. How do you understand these differences? A: The mention of a 15% to 20% drop in the guidance is related to the slowing macro environment in the market. These two products have differences in their timelines, so they are not completely synchronous, but they are both affected by the market.

Q: In the balance sheet, long-term debt is classified as short-term payments. Does this mean that you want to reduce the debt ratio? Will the capital expenditures of 3 billion be maintained in the long term? What are the main investment directions?

A: Regarding the USD debt, as it will mature in January next year. It needs to be converted into one-year debt according to accounting standards, and we are considering ways to cope with it.

The market may have been a bit sluggish this year, but there are plenty of opportunities for product and business upgrades and optimizations. Secondly, whether it is lenses or camera modules, we are constantly diversifying our customer base and allocating our resources more evenly across different parts. So, to put it more bluntly, Apple's market share will continue to increase. As for the camera module, we are focusing on the high specifications of Samsung products, hoping that our market share in this customer will increase, and we will further develop mobile phone lenses and camera modules in the next few years. At the same time, it is very important for us to maintain sufficient funds to prepare for the development of AR, VR and other emerging optical trends in the future.

Q: Apart from the vehicle-mounted lenses, are there any changes compared to the guidance released in March for other vehicle-related products such as LIDAR, HUD, and others?

A: The annual revenue target for car camera modules is 1 billion, and it has not changed compared to the guidance released in March. As for vehicle-mounted lenses, we also gave you a guide of roughly 10% to 15% growth. For LIDAR, we did not provide a detailed target, but we think the expectation is consistent with March. We now have 30 designated points, including OEM, optical components, and electronic modules, and the guidance has not changed compared to March.

Q: What is Foxconn's competitive advantage in the VR Pancake? Where is the competitive point in this industry? What will Foxconn's market share be in the second half of the year?

A: The world's leading VR Pancake companies have designated us to make products for them, which shows our competitive advantage. We have 2 core capabilities in our VR Pancake solution. One is the need for strong optical expertise to handle polarized light, and we are experts in optical solutions. For companies that do not have this expertise, it is impossible for them to meet the requirements. In addition, precise calibration is required, such as calibration between 2 different modules and AA, which are also strengths of Foxconn. Simply put, we have two highlights. The first is AA calibration, and the second is optical expertise, which is why large companies choose us as their supplier.

Q: The first question is about the production expansion plan, including production capacity plans for mobile phones and lenses, camera lenses, vehicle-mounted lenses, and vehicle camera modules. Has there been any changes?

A: Capacity planning is unchanged from March; Phone lenses: 180-190 million, newly added for North America; Phone modules: 75 million unchanged; Car lenses: 7.5 million increased to 8 million.

Q: The competition for low-end mobile phone lenses has been intense this year, with some price wars emerging. What is your view on the pricing of Chaoyu's phone lens products?

A: Regarding mobile phone camera lenses, there was a relatively high decline in the first half of the year due to the impact of the overall environment, about 10%-15%, which was slightly lower compared to the second half of 2021. The ASP in the second half of this year should be relatively stable.

Q: The Smart Phone Industry Outlook on Investor Day mentioned that global smartphone sales may decline by 8%, and China may be 16%-17%. Why is your guidance even lower than previously predicted? Is it because of protecting ASP or gross margin? Do you have any selectivity on projects?

A: During the Investor Day, we shared some data. But now, our OEM companies update all these data every month, not because we want to ensure ASP, and then we will give up some market share. What we see is that the future situation is still very grim. Therefore, we are willing to inform everyone of the latest situation, and maintaining market share and increasing R&D is our focus.

Q: In terms of AR/VR, you had a growth of 11% in the first half of this year. So can you achieve the 50% growth that you shared for the whole year?

A: For AR/VR, our guidance is still 50%, unchanged.

Q: With the expansion of domestic customers, ASP may decrease. Is there an upward trend for car lenses, and what will be the ASP situation this year?

A: The ASP of car lenses is affected by two factors. The automotive track is clear, with many competitors in mobile phone lenses, which results in more intense competition. The other factor is providing space for technical upgrades, such as defrosting and defogging functions, which can drive growth in ASP. With an output of 70-80 million mobile phone lenses, there is room for improvement in the product structure and ASP which needs to be gradually improved. The ASP of car lenses is roughly the same as last year, with a slight increase. The ASP in the second half is roughly the same as last year. The overall trend in ASP has room for improvement.

Q: The proportion of high-end products in phone modules has increased. But we all know that the module industry is currently in a price war. What is the bottom-line guidance for future gross margin trends?

A: If the industry's competition situation remains unchanged, then I think the gross margin for phone modules should be between 10%-12%.

Q: Is the decline in ASP of mobile phone lenses and modules due to downsizing or competition? Can you rank the reasons? Considering factors such as capacity utilization and competition, what is the trend for the second half of this year?

A: The main reason is downsizing, but this is a comprehensive problem. Although there is downsizing and downgrading now, there is still room for improvement in the functional aspects of the modules. Therefore, the camera function of new mobile phones this year needs to be improved. If we have this opportunity, then for companies with higher technological competitiveness in this industry, this should be our chance. Secondly, for higher-end products, we can see that market share is increasing. Therefore, our reason for expanding production capacity is because our competitiveness in high-end modules is still increasing. If overall sales remain the same or decrease, the proportion of high-end products will be higher. This is the competitiveness that we are enhancing.

Q: Is the decline in the shipment of in-car cameras due to the lack of chips or is the demand decreasing?

A: The trend is clear. Currently, the consensus is that intelligent vehicles are increasing, which means that the number of cameras on vehicles will increase. However, due to the chip shortage, growth in the first half of this year was only 0.8%. Therefore, if we achieve our 15% annual goal in the second half of this year, this means that our growth in the second half of the year should reach around 30% to achieve this goal. So, there should be a higher increase in the second half of the year.

Q: Are there any products besides those already mentioned, such as laser radar, AR, VR, and HUD, that could exceed expectations?

A: There has been a lot of discussion about VR for many years, and growth takes time. We believe that virtual reality has great potential. After VR, we have AR, but it will take some time for it to become commercialized and successful in the market. Nevertheless, we anticipate its potential, which is why we will continue to invest in this field. This is also why we have relatively high research and development costs, because we believe that future emerging deployments will require our investment.

Q: What is the competitive edge of laser radar? How do you evaluate the communications industry, as well as competitors engaged in optical modules and optical modules? Can you provide us with some revenue guidance for next year?

A: In terms of optical modules, we are currently considering silicon light, especially in IDC. They currently use 400g packaging. After our research, we have found that new packaging has higher accuracy than traditional packaging companies. In my understanding, their accuracy is one order of magnitude lower than ours, so I believe we have a higher competitiveness than them. In terms of optical module assembly, we have a very clear advantage in accuracy, and our assembly accuracy is very high. For example, in CUV and AA, we have achieved a level of microns or sub-microns. From optical components, equipment, prisms, assembly, AA, and OEM, we have all these abilities, enabling us to stand out in the competition. But most importantly, we do not directly compete with laser radar manufacturers. Instead, we are empowering them. If they have advantages in certain areas, we can authorize them and support them in developing these businesses.

Q14: What is the difference between an A-PHY interface chip module and MPI? Is there any guidance for next year?

A: The MIPI signal has a short distance and is far from the MCU, so it needs to be serialized and deserialized. Then transfer it via LVDS to the ECU and then convert it back to MIPL. A-PHY is an upgrade to MIPI. First, it solves the problem of expensive LVDS wires. Japan is working on it, and now it is possible to transmit signals using ordinary wires such as twisted pairs, which reduces the cost of wiring in the car. The second step is to see if there is an opportunity to avoid passing through MIPI conversion. Many major companies are collaborating with Valens, an investment in Israel, and many major OEMs are very interested. After all, American and TI chips are expensive, and cables are expensive. The cost of downgrading lines is very attractive to high-bandwidth applications. Currently, there is no designated time yet for this, but we are actively working with many partners and hope to have more clear results in the second half of this year or next year.

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