Lite-On Technology Corp

TWSE:2301

Earnings Call Analysis

LITEON Q2 Shows Growth in High-Value Segments

In Q2 2023, LITEON Technology's net sales were TWD 37.3 billion, marking a 9% Q-o-Q increase but a 13% Y-o-Y drop, mainly due to the disposal of the imaging business unit last year. The high-value and high-growth segments, which include cloud computing power supplies, auto electronics, and 5G networking products, witnessed sales growth, countering the weak consumer electronics demand. Gross profit rate improved, up 4.5 percentage points Q-o-Q and 2.9 percentage points Y-o-Y, reaching 23.3% due to a greater mix of high-end products, efficient supply chain management, and operational optimization. Operating profit doubled from the previous quarter, while net after-tax profit jumped nearly 80% Q-o-Q to TWD 4.2 billion, resulting in an EPS of TWD 1.84, a 6% Y-o-Y increase. The H1 2023 figures also reflected growth in high-value business, with a net sales of TWD 71.5 billion and an 8% annual increase in EPS to TWD 2.86. As the company focuses on investments in cloud, auto electronics, 5G, and new businesses, reflecting an R&D expense growth of over 10% Y-o-Y, it remains well-poised for future growth with an approved cash dividend of TWD 2 per share for Q2.

Overview of LITEON Technology's Financial Performance in Q2 2023

In the second quarter of 2023, LITEON Technology reported net sales of approximately TWD 37.3 billion, of which high-value and high-growth businesses like cloud computing power supply, auto electronics, and 5G networking products demonstrated year-over-year growth. The gross profit reached TWD 8.7 billion, translating to a rate of 23.3%, marking an increase both quarter-over-quarter and year-over-year. Operating expenses slightly rose, primarily due to strategic investments in R&D which constituted 5.2% of net sales. These efforts contributed to an operating profit of TWD 4.3 billion, doubling from the previous quarter and maintaining stability year-over-year. Earnings per share (EPS) for the quarter increased by 6% to TWD 1.84.

First Half of 2023: Strengthening Core Business and Profitability

Looking at the half-year mark, LITEON's net sales totaled TWD 71.5 billion, with notable growth seen in segments that have undergone strategic alignment towards high-value operations. The gross profit margin and operating profit margin improved to 21.1% and 9.1%, respectively, showing signs of resilience and quality growth in its high-end business portfolio. Net profits before tax soared to TWD 8.3 billion, and the company recognized a reduced impact from prior investment evaluation losses, which contributed to a net profit attributable to the parent of TWD 6.6 billion. Consequently, the EPS for H1 increased by 8% to TWD 2.86.

Segment Performance and Growth Drivers in Q2

Breaking down the company's performance by segments, both Opto-electronics and Cloud & AIoT segments showed promising growth, together accounting for 57% of the net sales. These segments were bolstered by increased demand and improvements in high-end product gross profits, exceeding 30% in Opto-electronics and 25% in Cloud & AIoT. Additionally, the ITC segment reflected growth due to a mix of urgent PC orders and product mix optimization, resulting in an operating profit of TWD 2.7 billion, a significant increase from the previous quarter.

Balance Sheet and Shareholder Value Indicators

Year-over-year, LITEON improved its working capital management, as evident by reductions in accounts receivable, inventory, and bank borrowings. This fiscal discipline led to a decrease in the number of inventory days and the cash conversion cycle. Meanwhile, the book value per share (BVPS) increased by 6% to TWD 35, signaling a rise in the company's intrinsic value. The company also announced a cash dividend of TWD 2 per share for Q2, underlining its commitment to shareholder returns.

Earnings Call Transcript 2023-Q2

[Operator]

Dear investors and friends from the media, welcome to LITEON Technology's 2023 Q2 Fiscal Earnings Conference. In addition to explaining the operating results of Q2 and H1, we also hope that everyone will better understand LITEON's growth strategy after completing many operational adjustments and transformation in recent years. Our meeting will begin when everybody is seated.

Today's agenda consists of 3 parts. I'll first explain the results and financial performance of Q2 and H1. Next President, Anson, will explain the company's operating outlook and growth strategy. The Q&A session is open for questions and further explanations. For those who are here for the first time, this page provides you with an introduction to the 3 major business segments which are: Opto-electronics, including opto-electronics, semiconductors and auto electronics; Cloud & AIoT mainly used in data centers, servers, networking products, AI, IoT, et cetera. ITC used in notebooks, workstations, desktop computers, game consoles, et cetera.

LITEON Technology's net sales in Q2 was TWD 37.3 billion. Gross profit, TWD 8.7 billion with a GP rate of 23.3%. Operating expense, TWD 4.4 billion with a rate of 11.7%. Operating profit, TWD 4.3 billion with a rate of 11.6%. Overall, net sales in Q2 was up 9% Q-o-Q and down 13% Y-o-Y is excluding the imagery BU that was disposed of last year, the net sales decreased by 7% Q-o-Q.

Demand for consumer electronics remained weak in Q2, but the net sales of high-value and high-growth businesses, such as cloud computing power supply, auto electronics, 5G networking products continue to grow Y-o-Y. The GP benefited from the increasing proportion of high-end products, close supply chain cooperation and optimization of operating efficiency. The GP rate was up by 4.5 percentage points Q-o-Q and 2.9 percentage points Y-o-Y.

The operating expense was up by 2% Q-o-Q and down by 1% Y-o-Y. The increase is mainly due to R&D investment. In Q2, R&D expenses accounted for 5.2% of the net sales and the amount increased by 10% Y-o-Y. Among the R&D investment, cloud power supply, auto electronics and 5G networking products accounted for a higher proportion.

The operating profit doubled Q-o-Q and was flat Y-o-Y. The operating profit rate increased by 5.3 percentage points Q-o-Q and 1.4 percentage points Y-o-Y. Net other income was TWD 970 million, an increase of TWD 150 million and TWD 300 million Q-o-Q and Y-o-Y, mainly reflecting rising market interest rates. So net interest income increased.

The profit before tax was TWD 5.3 billion and a profit attributable to parent was TWD 4.2 billion, an increase of nearly 80% Q-o-Q, respectively. The EPS was TWD 1.84, an annual increase of 6%.

In terms of the operating results in H1 2023, the net sales in H1 was TWD 71.5 billion. The gross profit was TWD 15.1 billion with a GP rate of 21.1%. The operating expense was TWD 8.6 billion with a rate of 12.1%. The operating profit was TWD 6.5 billion with a rate of 9.1%. In Y-o-Y terms if excluding the imaging BU that has been disposed of, the next sales decreased by 10%.

In H1 despite the restructuring of the electronics industry, high-value businesses continue to grow. The operating GP increased by 2.3 percentage points Y-o-Y, and the operating profit rate increased by 0.4 percentage points Y-o-Y, which all reflect the synergy of flexible and resilient operations and high-quality growth of the high-end businesses.

The operating expense increased by 2% Y-o-Y, in which R&D accounted for 5.3% of the total net sales with an annual growth rate of more than 10% mainly focusing on improving the value of core products and investing in new businesses.

The net other income was TWD 1.8 billion with an annual increase of TWD 1.5 billion. The main difference is that in H1 last year, there was a recognition of an investment evaluation loss for VIZIO of about TWD 1.2 billion, and the impact on us in H1 this year was greatly reduced.

In addition, in response to market interest rate hikes this year, net interest income increased. In H1 this year, the net profit before tax was TWD 8.3 billion and the profit attributable to parent was TWD 6.6 billion. The EPS was TWD 2.86, an annual increase of 8%.

In Q2 2023, the net sales and profits of the 3 major segments all grew Q-o-Q. In Q2, the 2 major segments, Opto-electronics, including auto electronics and Cloud & AIoT accounted for 57% of the net sales. The 3 major business segments continue to optimize product and client mixes. Among them the net sales of the Opto-electronics segment, including auto electronics was TWD 7.9 billion, up 4% Q-o-Q. This is mainly due to the recovery in demand from Opto-electronics, semiconductors and EV clients, the GP of high-end products exceeded 30%. Operating profit, TWD 760 million, up nearly 60% Q-o-Q. Cloud & AIoT net sales was TWD 13.2 billion, up 9% Q-o-Q. This is mainly due to the increasing proportion of high voltage, high efficiency and high density high-end power supply required for cloud computing, the GP of high-end products exceeded 25%.

Operating profit, TWD 1.6 billion, doubled Q-o-Q. In ITC, the net sales was TWD 16.1 billion, up 12% Q-o-Q, which reflects the recent PC urgent order effect and product mix optimization. The GP of higher products was over 18%.

Operating profit, TWD 2.7 billion, up nearly 50% Q-o-Q. As for the balance sheet, among the current assets in Q2 in Y-o-Y terms, accounts receivable down by TWD 8.6 billion and inventory down by TWD 7.4 billion.

In current liabilities, bank borrowings down by TWD 8.2 billion Y-o-Y and accounts payable down by TWD 5.7 billion Y-o-Y. Our working capital management includes accounts receivable, accounts payable and inventory levels. In Y-o-Y terms, the number of inventory days decreased by 9 days and a cash conversion cycle by 15 days, reflecting the improvement of working capital management. The net cash position was TWD 50.5 billion, down by about TWD 3.3 billion Q-o-Q mainly due to the cash dividend distribution of TWD 7 billion from Q4 last year.

Through active working capital management and free cash inflows from operations, we prepare for and help the future improvement of business performance investment and growth of core businesses. The BVPS increased from TWD 33 to TWD 35 [indiscernible] , up 6% Q-o-Q and Y-o-Y, which shows that the intrinsic value continues to increase.

Operation overview for Q2 and H1 of 2023. In H2, the net sales was TWD 37.3 billion, and the growth came from cloud computing, power supply, auto-electronics and 5G networking products. GP benefited from the increasing proportion of high-growth, high-value businesses, close cooperation with the supply chain and optimizing operating efficiency. The GP increased by 2.9 percentage points to 23.3% Y-o-Y. The open rate increased by 1.4 percentage points to 11.6% Y-o-Y.

In operating expense of Q2, R&D investment accounted for 5.2% of the net sales and annual increase of more than 10%. We continue to focus on investment in cloud, auto electronics, 5G and new businesses. In Q2, the net profit after tax was TWD 4.2 billion. EPS, TWD 1.84, an increase of 6% Y-o-Y. At noon today, the just approved a cash dividend of TWD 2 per share for Q2 2023.

The net sales in H1 this year was TWD 71.5 billion. GP rate 21.1%, the OP rate was 9.1% within Y-o-Y increase of 2.3 and 0.4 percentage points, respectively. EPS TWD 2.86, an Y-o-Y increase of 8%. This concludes the financial report for H1 2023. I'm now handing over to President, Anson. He will explain to you the company's operating outlook and long-term growth strategy. Thanks.

[Anson Chiu, executive]

This is really the first time in 3 years I've seen so many investors, shareholders and media friends to participate in our earnings conference. Since taking office 3 years ago, the new management team has made every effort to promote

Lite-On's transformation and a market-oriented growth strategy -- and we actively invest in R&D. And at the same time, we highly integrate resources such as business, manufacturing and procurement.

The main purpose is to meet the needs of clients as much as possible and maintain a highly flexible and resilient functional organization to continue our n

Lite-On sales growth. Looking back 3 years later on this basis, Lite-On has precisely selected its tracks and concentrated its resources on developing high-value and high-growth businesses such as cloud computing, auto electronics and 5G networks, et cetera. This allows us to successfully grasp the time to market.

In the new cloud power supply application field, we enter a new market and obtain a good market position. Under such a successful model, we will continue to replicate this successful experience in the development of various new businesses to speed up the development of new businesses.

For example, the 5G networking products business has been difficult to promote in the past 3 years due to the pandemic. However, since the lifting of pandemic restrictions, networking products, 5G business has performed well in Q2.

In particular, 5G small base stations have successfully entered the Southeast Asian, Japanese and European markets outside the Taiwan market as the pandemic eased. In the future, LITEON will gradually develop the new businesses as we -- that we have targeted with such a model and transform into a growth-oriented enterprise more quickly. Julia also mentioned just now that overall, the environment industry and market in the first half of this year are undergoing continuous corrections in terms of our own businesses nearly of about 40% of LITEON's products belong to the ITC and consumer products industries.

As mentioned in Julia's report just now, our market is also affected by these corrections. So originally, we were still optimistic about Q2 and the second half of the year. But right now, it seems that in the industries that we just mentioned, including general purpose servers, things might be slightly below what I told you back in Q1 but we have also made some adjustments inside the company.

We have strived to enhance our products, which is basically about low quantity, high variety, high voltage and high added value through improving product mix. We hope that our businesses can stay away from market impact.

On the other hand, in terms of cloud computing, auto electronics, 5G and AIoT, positive growth still remains. We are still quite optimistic about these 3 major business segments. We've just seen the earnings from Q2. And in Q3 and in Q4, we believe that there is still a chance to grow Q-o-Q. When it comes to Q3, I'm sure that you are concerned about where the growth will come from.

Let me tell you this. In the 3 major business segments of the company, each 1 of them will still have a chance to grow Q-o-Q. This is why, as I said, we will continue to enhance and optimize our product mix. In terms of growth, what might be slightly different is in cloud computing, high-end cloud computing. So the differences are bigger and more obvious.

And in terms of auto electronics and we are still moving towards the direction of positive growth. The reason why we can say this is because over the last 2 years, we told you that the company's operation has always focused on growing profits and growing net sales at the same time. And we have especially asked ourselves internally that our growth -- profit growth should be higher than net sales growth.

And over the past 2 years, you've seen that we walked exactly on this path. At the same time, one very important thing is that we continue to enhance, to increase our R&D investment if you have paid attention to our R&D investment in the long run, you can see that over the last 2 years, the percentage of our R&D investment has gone up significantly. So through these new markets, products and track. We hope that with R&D resources, we want to implement our products as fast as possible on these markets and tracks.

So I mentioned that growth will come from cloud computing, auto electronics, and AIoT and 5G. And previously, I also told you that in the future, energy would play a very important role. We have started our planning. We start from energy storage we talk about energy storage saving, control and transformation and IOE, Internet of Energy, but we start from energy storage that 1 goes faster than the other aspects. Last but not least, ESG then our sustainability report this year was just published. And back in May, we mentioned the 555 carbon reduction action. What does that mean?

Well, by 2050, we promised to achieve 0 carbon emissions. Actually, we started back in 2014 already, not just this year. Every year, we as our sold internally to reduce carbon emissions by 5%. For our new generation products, the carbon footprint along our supply chain needs to reduce by 5% as well. So 555 represents such goals that -- all of our employees should aim to achieve. It's easy to remember. And in the future, we strive to achieve such goals. I'd also like to advertise for our light on LITEON shop. They have launched some summer additional products later after you visit our demo room you will see lighter little soft just next to it. If you have time, you can go there to have a look at our eco-friendly products that are impressive and innovative.

And in terms of corporate governance, we have once again won the Taiwan Stock Exchange recognition. We are once again among the 5 -- top 5% companies. This recognizes the company's performance in ESG. So this is what I want to share with you as well. dear investors, media friends and shareholders. If you're interested you can scan this to QR code on the screen to better understand what Lion has in terms of sustainability.

This concludes my initial presentation before answering your questions. Now the floor we'll be open for questions. We will provide you with more explanations. Thank you.

[Julia Wang, executive]

Thank you, Anson. Now with the Q&A session. We open the floor for questions, and we will provide further explanations. Doris from Merrill Lynch, please.

[Unknown Analyst]

Anson and Julia, this is Doris from Merrill Lynch. I have 3 questions you ask, should I ask them together or one by one?

[Anson Chiu, executive]

Well, either way.

[Unknown Analyst]

Okay. All of my 3 questions focus on AI super power supply. My first question is, currently, this product line accounts for how much of the company's net sales? And for this year, next year and in 2 years' time, does the management team have any forecast or expectations for this product percentage. And we know that the GP of AI server power supply is much higher than regular servers.

So could you give us some direction in terms of how high it can reach. And if we want to benchmark against our current products where the highest level is Opto-electronics. Is it possible for AI server power supply to achieve that level.

Third, indeed, there's only LITEON and another company that are leading in AI server power supply technologies. So how can LITEON compete with this major competitor to enlarge your market share and to maintain your distance -- the distance between you and the companies in the third and fourth positions.

[Anson Chiu, executive]

Thank you for your questions. We all know that AI has been heard and popular recently. So these questions are also a bit hot and difficult to answer, but I will try my best according to my understanding.

The company's AI plannings started 3 years ago already. So we didn't just start this year. And we have had this opportunity to present our products and technologies to our clients. However, we only started to enter into business in H1 this year. We had a little bit of shipment in H1 this year. we are still in a beginning, rising phase. So I can tell you that if you look at H1 and H2 this year, and if we only look at AI server power supply, our growth in H2 will be a few times higher than that in H1.

As for the percentage right now, it is still very low. But the quantity is still low. And if we look at the amount -- this year, it will be around between 5% and 8%. This is our initial escalation as for next year and in 2 years' time, as technologies become more mature and as GPU supply problems can be solved gradually. I think that the demand next year can be more optimistic it can increase by 10% to 15% roughly. We believe that the AI trend is in elastic demand. It's not like optional product. So we are quite optimistic.

When we look at the development trend for the next 2 years, AI will enjoy a higher percentage. You also asked about general purpose for regular servers as AI grows some demand will shift from general purpose to AI servers. The reason is because there's always a prioritization in investment, in my opinion. So -- right now, most people on the market first put capital on AI, but it doesn't mean that dual-purpose demand will go down. Indeed, this year, the demand has gone down by around 10%.

But we still believe that next year, it will return to normal. And as the market returns to a normal and rational level, it will return to a positive growth pack. So there shouldn't be a problem. It's not that AI servers will replace all the general-purpose servers.

As for your question about our competitor, I want to correct 1 thing. In terms of AI, we believe that we are leading. We don't really lag behind our major competitor. Of course, if you look at high-powered cloud, AI servers to calculate, of course, we are about next to neck with our major competitor. This is a fact. But we are leading in terms of AI technologies. We have spent 2 to 3 years trying to do 2 things well. The first is that -- well, the major functional difference between general purpose and AI servers is that general purpose 12 bit output and power supply is 54 bit output, which means that the efficiency has to increase.

For example, general purpose servers, the market requirement is 96% conversion rate. But now for AI, the market requirement is 97.5, which is quite challenging on that even though it's just 1.5 percentage points, this is why we have spent so much time trying to other advance our technologies. And second, as high current increases, the instantaneous current requirement is also higher than that for general-purpose servers. And due to these 2 factors, technologically, AI server power supply is more challenging. But we are already -- we don't just look at our competitor. We don't know what they will do, but we can be sure about that we are taking the lead. So this is how I would answer your questions.

[Unknown Analyst]

Anson and Julia, I have a few questions. Let's first return to the earnings of Q2. If we look at different segments, ICT's OP margin rate in Q2 was very good. Could you further explain, I know that you mentioned product mix improvement and supply chain cooperation. But I want to know if it can last. And second, Cloud & AIoT's OP margin in Q2 was very good. And we know that there are 2 units in this segment. So in Q2, IoT and cloud both performed well or IoT was just average the cloud performed better. I want to know such details.

Second, I want to ask about charges because a lot of people in North America are moving towards Tesla's NACS specs. So Anson, from your industry observations, how do you look at this? What is the impact on the industry development? For example, people may need to pause to modify product specs. So in the short run, things may not be that good. But in the long run, the market will still move ahead. Well, maybe this is not the case. What do you think?

And also back to LITEON itself and LITEON's businesses. In the past, LITEON worked more on carmakers, and now the focus is more on operators. So in terms of your businesses, what are the different impacts and changes between operators and carmakers.

[Anson Chiu, executive]

Okay. So you also have 3 questions. In digital homework, you saw that ICT's GP went up. At the same time, cloud GP and OP also went up. And according to Julia's presentation, auto electronics GP also went up in Q2.

So how did ICT's GP go up in Q2? Well, as I said at the beginning, product mix. We all know that our consumer products such as game consoles, desktops and notebooks. We have the largest market share worldwide. We are #1 in terms of global market share. So how can we continue to grow? Well, we have to change the product content. In the past, our operation focus more on major customers in mainstream models because we thought that we were better at mass production. But this mentality has gradually changed over the past 2 to 3 years. So our consumer products such as game consoles and even including keyboards and mouses. We are moving towards the higher end with lower quantity and higher variety. So in Q2, our high-end products had grown from 30% to roughly 40%. This means that our team has been going up. And as you may know, the higher in the product, the higher it's GP because it's more difficult to make technologically. So there are fewer competitors. The same applies to cloud.

And of course, cloud also benefited from the AI product mix in H1. So through such a product mix, our GP gradually went up but we don't want our competitors to know our GP. So I cannot really answer your question clearly bear with me.

As for chargers in North America, people are starting to move towards NACS. This is the North American charging system and this is the same as Tesla, and this simply means that we have to meet such a suspect. If we want to do that, then our design of hardware and software need to change, which shouldn't be a big problem. This is simply about satisfying customization requests. For example, in terms of systems, software, et cetera. So when things are unified, let me give you a simple example. We have a unified charger more and more Type C. There is an advantage to that.

The demand can rapidly increase with such a unification. So from our perspective, in the long run, this is actually good news. In the short run, the impact is that we need to make some specs adjustment.

Let me also tell you that in Q3, we will launch DC charges, which worked exactly with this system. This is actually not new. About 2 quarters ago, we knew this trend on the market. So we planned accordingly in advance. So there isn't a big impact on us. Previously, for 2 years, we focused on Level 2 more mounted charges from 7.5 to 220-watt charges, and we mainly supply to service providers gradually, over the past 1 year, we have moved towards carmakers to supply our solutions and mainly DC chargers, we believe that when we look at the future growth trend compared to Level 2, we believe that Level 3 will enjoy greater growth, and we will have to work closely with carmakers. So this is how I would answer your 3 questions.

[Sharon Shih, analyst]

This is Sharon from Morgan Stanley. I have 2 questions to ask. First of all, I would like to verify something Anson talked about AI server power supplies contribution. You said that in H2, it would be 5% to 8%. Is it against the total power supply? Or is it against the entire company's net sales?

[Julia Wang, executive]

Well, let me answer you first. I was referring to high power or higher-end power supply because there's also middle power, right. So what I meant was high power, but AI is above 3,000, 5,000 watt, which is a different segment. So here, we don't consider it as part of the ITC products, we consider it as part of the cloud computing products. So I was saying that in the high-power business in H2 in terms of net sales this is the percentage range.

So I'm trying to understand, if we use this slide and its categorization in the cloud and IoT segment, how much is it high-power accounts for how much of the net sales in this segment. Well, if we look at Q2, it accounts for 36% of the company's net sales. But if we look more closely, cloud-related is out of it, while AIoT accounts for 40% of the net sales of this segment. So Anson was talking about high powerful server using cloud computing in terms of net sales.

[Sharon Shih, analyst]

Okay. So in this 36%, there's 60% then out of it, 5% to 8%, right?

[Julia Wang, executive]

Yes.

[Sharon Shih, analyst]

My second question is also about what Anson said you are moving towards 3k, 5k watt in your development. When we look at power supply units things are going towards higher voltage. But in terms of -- if we look at things from the perspective of data center operation in addition to servers, there is power supply needs in large data centers, right?

So could you share with us from Lion's perspective, what are your plannings in addition to power supply units -- what are your planning related to data center power supply and how fast can they contribute to your net sales?

[Anson Chiu, executive]

For this question, in addition to cloud computing power supply, we have 2 major planning. The first 1 is institutions we already had enclosure institutions. But in the past, we only worked on relatively lower end products over the past 2 years, that percentage has been going down. We are going through such a transformation towards cloud or Reg design capabilities.

This year, we actually -- there was a little bit of business this year, but not much. This is why we didn't mention it specifically, but we did send out some samples to CSP clients which they are evaluating, including AI. Second, previously, we also mentioned this. Both general purpose or AI servers are both going towards higher voltage. And 1 important thing is that space cannot be further enlarged.

No 1 would want to make the specs larger rather people are trying to make things smaller in order to leave space for other days. So heat becomes a very serious headache -- you can see that on the market. There's a lot of discussion about heat in different cooling mechanisms such as liquid late pooling or eventually immersion cooling or water cooling, we believe that as par voltage becomes higher and higher in the future, we must have to go towards water cooling or immersion cooling, but no 1 can predict for sure right now because it depends ultimately on the clients' design specs and what kind of value power solutions can provide.

Actually, LITEON started our planning last year and our first generation products were displayed in the OCP exhibition. But after that, we thought that there would still be a lot of room for improvement. So in October, we will launch our second-generation solutions, which we will launching the OCP in the Czech Republic. So these are the 2 major things that we can see right now.

[Anne Lee, analyst]

Anson And Julia, I'm Anne from Nomura. My first question is about Consumer Products margin that you just talked about. Well, improving product mix? Was it due to the fact that in Q2, there were some PCs, notebooks urgent orders and can we see that too in H2. And during the opening, Julia talked about the cooperation between vendors to reduce cost, will it still -- will there still be room for that in the future. And right now, market is not very good. So some clients they want to reflect cost reduction for them? Can it also happen in H2?

[Julia Wang, executive]

Well, to answer your first question, in terms of consumer products, be them adapters, desktops or gaming keyboards and mouses our growth mainly comes from the increasing percentage of high-end products, for example, gaming adapters they go from 300 to 500-watt. As for desktops, in addition to the existing desktop computer products and applications, we also go into workstations, which can go as high as 1,000 watts these are the things that we've only started to approach over the last 2 years.

In the past, we thought that the volume was not high, so we didn't really want to do it. But over the last 2 years, the demand has been going up. So we also started lease. So it has to do with product mix rather than urgent order effect. If the percentage remains that in H2, it can be at the same level as Q2 or even better because traditionally, in Q3, it's the high season for such products. And right now, of course, the market demand is relatively weak.

Some clients may ask for support from us, which we think is normal. There's nothing strange about it because it's always been like this. This has to do with the market mechanism. When prices went up, we also reflected that with our clients, the same applies to now. What we need to do well is that we want to make sure that our products are competitive and we want to optimize our design, our supply chain and our manufacturing so that we can maintain our necessary GP.

So when clients come to us to ask for cost reduction, price reduction, we don't think that it's necessarily problematic. We think that it's normal, and there isn't really an impact.

[Anne Lee, analyst]

Okay, very clear. My next question is about cloud power. AI power, as Anson just said, only started this year. But if I remember correctly, last year, there were quite a few cloud clients, which may not be related to a -- they had 3,500 watt, and this year, probably 4,000. So it's in the range that you mentioned. So is it part of the 5% to 8%?

[Anson Chiu, executive]

Yes. Because we realized that some clients use them for GPU and AI servers. So we consider them as part of the 5% to 8%.

[Anne Lee, analyst]

Well, if that's the case, then these clients last year already had a large market share, right?

[Julia Wang, executive]

Well, no, I have to clarify this. this only started mass production this year. Last year, our growth mainly came from networking and communications, but the wattage was not that high. It's below 3,000 or even just 2,00, 1,000. A last year, high voltage had a low percentage relatively. But this year, because of a purpose clients or pure AI clients, which are new their voltage is higher.

At the beginning of this year, the volume wasn't high, but it's been going up. We believe that in H2, it will continue to go up. Well, but for such clients, if they are still general purpose, but if they use DPUs PSU, is it also part of the 5% to 8%. Well, that is not used for AI. It's purely for general purpose.

[Anne Lee, analyst]

Yes, right. But I'm a bit confused by it now because voltage is above 3,000 as well.

[Julia Wang, executive]

Well, we shouldn't use 3,000 watt as a definition because there are also things about 3,000 watt for general purpose. But if we look at our major client, they use it for general purpose basically. But for things that are for AI, the starting voltage is higher. So we don't really use voltage to determine whether something is AI or not. We look at the application.

[Anne Lee, analyst]

Okay. So this 5% to 8% is AI purpose clients, excluding general purpose, even if it's above 3,000, right?

[Julia Wang, executive]

We look at the application to determine whether something is to purpose or AI. Sometimes, the power is used for networking, and it's around 200 watts. So it really depends on the application to determine what it is.

Sometimes there is edge computing, right, which is related to AI, but the voltage is below 2,000. So do you consider it as part of AI? No. Okay. So the definition of this segment is really about 3,000 with a purpose of AI, right? It's used for AI computing servers. What about inference?

[Anson Chiu, executive]

No, we don't consider it as part of it. Well, I can add 1 point here. Later, if you have time, you can come to our showroom where we have a clear categorization we have power for AI servers we have power for networking and telecom, we have PSUs, BBU power cell. We show that separately. So seeing is believing. .

[Unknown Analyst]

Anson and Julia, I have 1 question to ask. I don't know if you have already explained this because I arrived a bit late. In Q2, the GP and OP improved significantly. So when I look at the product mix, the 3 major segments haven't changed much. So I'm curious, from Q1 to Q2, the GP improved by a few percentage points. What are the main reasons? Is it because that under because under the main segments, there have been some adjustments of the items? Or is it because of something else? And can sustained in the future. In theory, in H2 and next year, AI power should account for a higher percentage, which should be a favorable factor, right? So could you share with us the reasons behind such an improvement.

[Julia Wang, executive]

This is a good question. Indeed, compared to Q1, the GP improved quite a lot in Q2. There are 3 main factors. First of all, material cost improvements, and this has to do with product mix. Those with good material cost so more and those with a good GP sell more. Second, in H2, R&B was quite favorable to us because it was depreciating, and we have many materials that are bought from Mainland China. So this was a big plus to us in Q2.

Third, in terms of raw materials, we had some cost reduction because we know that just as what we said a while ago, clients came to us to ask for price reduction. So we also negotiated with our suppliers accordingly. So in Q2, the price reduction was more significant than in June 1. And also, there is our manufacturing cost that plays a role over the last 2 years, if you have paid attention, the cost has gone from 15% to 13% with a reduction -- with a 1 percentage point of reduction for material costs.

So over the past 2 years, we have transformed ourselves using some digital tools to keep reducing our loss. So this is where we performed quite well in terms of manufacturing costs. And third, our inventory loss is also an important factor. In the past, there were some headwinds in the supply chain. So we prepare for quite a lot of inventories. But according to our accounting rules after a certain time, certain period of time, we need to list such inventories to prepare for potential loss.

In H1 this year, many of our colleagues spend a lot of time in trying to resolve this issue. So in H1, we consumed almost all the inventories that had been accumulated. It's difficult to say which factor accounts for how much percentage, but to these 3 factors, our GP improved significantly in Q2. But let me also to this, over the past few years, we have optimize our products. So low GP things have been going up low GPs have been going down and high GP things have been going up. 20 and 10 are the goals that we strive to achieve internally. I'm sure that in Q3 and Q4, we will continue to maintain such a GP. Of course, there are product mix and exchange rate factors, but I'm sure that we will be able to maintain the GP at this level.

[Unknown Analyst]

So 23% is something that you think that you will be able to maintain in H2 and next year, supposing that the exchange rate remains constant at a certain level, you are confident to maintain target?

[Julia Wang, executive]

Well, not necessarily 23%. We just said that are market changes and we adapt accordingly. For example, we may provide more rebate or price reduction for clients -- so in management, these are necessary measures. But as I said, 20 and 10 are the bottom line that we will not give up on.

[Unknown Analyst]

Understood. Well, before Q2 for a few quarters, you were slightly below 20%, such as 18% or 19%. Let me ask my question in a different way. Can we look at Q2 as a turning point, after which your GP will above 20%. And as for OP in the past, it was in single digits, maybe after Q2 you are more confident about that being above 10%.

[Anson Chiu, executive]

Yes, we are quite confident about that. And previously, we told you that we will try to improve our GP, but whether or not it can be at 23% or higher? Regardless, ultimately, we transfer that money earned towards our OpEx. For example, an increase of 1 percentage point will be invested in our R&D because the new tracks that we have selected require R&D resources more. So for GP. GP will continue to go up, but we will maintain the OP level. This is how we will do.

[Unknown Analyst]

Can I ask you -- could you talk a little bit about photo couplers, LITEON is leading quite a lot in this area. And for a few quarters, the market was not good. So how do you look at the next 2 quarters in terms of operation and outlook.

[Anson Chiu, executive]

This is also a good question. You pay attention to photo couplers, which is part of our Opto-electronics Well, right now, the consumer market and the IPC market are not quite good. So our digital like products, starting from Q1 last year started to when -- started to go down, and our photo couplers are used in IT products or in industrial automation products.

So photo couplers were also affected as a result. It wasn't until Q1 this year that we saw the bottom which means that there was about 1 year's correction. In Q1, we saw the bottom because we started to see demand coming in Q2. So -- so in Q2, the net sales of Opto-electronics turned out to be better than in Q1.

If we look at Q3 and Q4, according to the current projections, things can be better than in Q2. In addition to photo couplers, visible light products and in digital light products are also going up. There's an interesting phenomenon we can look at this component as a leading indicator because it reflects things earlier, it goes up earlier, and it goes down earlier as well.

So internally, in LITEON, we use it as a leading indicator. What I can tell you is that in Q1 and in Q2, this product was bottoming out and started to rebound. I think from the market perspective, maybe you can see things more clearly than I do. But internally, we are seeing that it's going up and recovering.

[Unknown Analyst]

I have 1 question. In the past, you did provide some -- the Y-o-Y growth for your core applications. I don't know you have numbers from Q2 such as cloud computing, et cetera.

[Anson Chiu, executive]

Yes, let me share with you very quickly the numbers. We just mentioned that when we look at Q2 and the high value, high growth businesses such as cloud power supply, 5G networking and auto electronics. In Q2, they all had Y-o-Y growth. Cloud power supply with more than 20% Y-o-Y growth. As for auto electronics, it was about 10% Y-o-Y growth. IoT is more moderate. It was in single digit.

[Unknown Analyst]

Another question. You did talk about Q3, but could you share with us the Q-o-Q patterns for Q3 based on past experience, and ups and downs. And also for the entire year of 2023, if you exclude the imaging BU that has been disposed of, what are your latest thoughts?

[Anson Chiu, executive]

Well, for Q3 last year was an exception because things were going down quarter after quarter because in the previous year, things were going up quarter after quarter. So if we average those 2 years, the track was similar to the past. So because of the COVID-19 pandemic, the 1-year cycle has become a 2-year cycle because people have to try to digest the inventories or the needs accumulated. So we've realized that last year was quite exceptional. Things were going down from Q1 to Q2, et cetera.

But as we said, we have to look at the track emphasize this once again, different tracks have different situations. So to answer your question, the track where we have growth are cloud auto electronics, these are the growing tracks. But when it comes to consumer products or ITC products or general-purpose servers, consumer products declined quite a lot in almost 30%. PCs declined between 10% and 20%. As for general-purpose servers they declined by 5% to 10% as well.

So the patterns and rhythms really depend on different tracks that would be more precise. But in general, it would be hard to differentiate good and bad things because some things go up, some things go down. So we need to look at different markets in order to be more accurate.

[Julia Wang, executive]

Okay. This concludes our earnings conference today. All the data will be put on to our official website. Thank you for your participation. We would like to invite you to come to our showroom. We have dedicated guys to show you our high-value, high-growth businesses. Thank you so much.

[Anson Chiu, executive]

You can take this opportunity to understand what we do. Thank you so much for your participation. [Statements in English on this transcript were spoken by an interpreter present on the live call.]