Delta Electronics Inc

TWSE:2308

Earnings Call Transcript 2018-Q2

[Unknown Executive]

Hello, everyone. Welcome to Delta 2018 Second Quarter Investor Conference. We will start right now. Yesterday, we made the announcement regarding the transaction between Delta Electronics and Delta Thailand. But firstly, we will still have our IR Manager to report the financial numbers of second quarter, and after that, we will have the Q&A session.

[Rodney Liu, executive]

So before we start, I need to remind you that the financial numbers are reported based on IFRS, and the consolidated numbers have been reviewed by CPA.

With the tailwinds from NT dollar depreciation as well as consolidation of VIVOTEK since last October, Q2 sales revenue was TWD 57.9 billion, up 14% Q-o-Q and 8% Y-o-Y. Sequentially, we saw a pretty even [ since new ] interest with average 13 to 15 growth in each segment, and therefore, the mix of second quarter looks quite similar to the previous quarter. Year-on-year we still saw the strongest growth from Automation segment, however, which was mostly contributed by the growth of Building Automation, especially from the consolidation of VIVOTEK rather than the growth of the IA business.

The gross profit in second quarter was TWD 14.5 billion, up 11% Q-o-Q, but down 1% Y-o-Y. Similar to the previous quarter, GP margin was still under significant pressure mainly due to the price increase of many different types of components and materials. Therefore, even with the higher utilization rate, Q2 gross margin contracted a little bit to 25.1% from 25.6% in Q1. With the battery [ scale ], R&D expenses as a percentage of sales decreased to 7.8% in Q2 from 8.3% in Q1. Likewise, SG&A as a percentage of sales decreased to 11.2% in Q2 from 11.8% in Q1 and 11.4% from a year ago. So the total OpEx number in Q2 was TWD 11 billion, representing a 7% increase Q-on-Q and a 9% increase Y-o-Y. So the percentage wise, the OpEx ratio was picking up from 20.1% in Q1 to 19% in Q2.

With the disadvantage of having those pressures, our operating profit was up 27% Q-o-Q, but down 23% Y-o-Y. So the OpEx -- so the OP margin in Q2 was 6.1%.

So here, we provide some breakdown of operating profit by sector for your reference. Apart from the increasing cost pressure across the board, year-on-year, we saw the biggest profit decline in Power Electronics, which was largely related to the fast growth of our EV solutions business as the business still requires some investment into R&D, capacity expansion as well as testing equipment. So the faster it grew, the more loss we made. But with the -- but we are actually quite upbeat about the outlook of this business, and we also believe the auto-related business will become one of our growth drivers in the next decade.

So in Q2, we had about TWD 900 million operating profit, which was quite similar to the historical numbers. We had TWD 4.4 billion profit before tax, which was up 18% Q-o-Q, but down 19% Y-o-Y, mainly due to the contraction of gross profit. Our EBITDA in Q2 was TWD 7.4 billion, which was up 11% Q-o-Q, but down 9% Y-o-Y.

Q2 tax expense was about TWD 1 billion, representing a 22.5% effective tax rate. So the net profit after tax in Q2 was TWD 3.3 billion, up 18% Q-o-Q, but down 23% Y-o-Y. So the EPS in Q2 was TWD 1.26.

So now we have a look at the accumulated numbers of the first half. The first half revenue was TWD 108.8 billion, which was 6% up from a year ago.

Year-on-year, we saw the strongest growth from Automation, followed by Infrastructure and a little decline from the -- in the Power Electronics. The fast growth of Automation was largely related to the consolidation of VIVOTEK. Due to the heavy cost pressures, the gross margin in first half declined to 25.3% from 27.3% a year ago. And the R&D expenses increased by 13% in first half compared to a year ago, while the SG&A also increased by 6% in first half, which was in line with the growth of our sales revenue in the first half.

So the total OpEx -- the OpEx ratio in first half increased to 19.5% from 19% a year ago. Due to the increasing cost pressures, the operating profit in first half was TWD 6.3 billion, while the operating margin dropped to 5.8% from 8.3% a year ago.

So again, we provide the operating profit breakdown for your reference. So in the first half, we have about TWD 1.9 billion in the operating profit, which was similar to the last year. But can we still provide some details for your reference.

So in total, we had TWD 8.2 billion pretax income, which was down 22% from a year ago.

So here we provide the EBITDA for your reference. Our EBITDA in the first half was TWD 14 billion, which was down 9% from a year ago.

So the tax expense in the first half was around TWD 1.9 billion, representing a 23% effective rate. So the net profit after tax in the first half dropped to TWD 6.1 billion from TWD 8.2 billion from a year ago. So based on our 2.6 billion outstanding shares, the EPS in first half was TWD 2.33.

[Unknown Analyst]

So my first question is regarding the transaction with Delta Thailand. How do -- are you going to finance this transaction?

[Unknown Executive]

So according to the tender offer we made for the Delta Thailand shareholders, actually, we can buy up to 79% at the price of THB 71 per share. So for your question on how to finance this transaction, actually we will use our own cash that's on our accounts, but also we may do a little bit leverage from the bank. And the good thing is Delta Thailand is also cash generative, so I think that wouldn't be a big issue for us.

[Unknown Analyst]

Do you have any plan -- my second question is, do you have any plan to reallocate your resources, especially in your China campus?

[Unknown Executive]

Okay. So actually this transaction is meant to enhance our flexibility of global manufacturing capacity because Delta Thailand has now -- actually has a manufacturing facilities in Thailand, India and Slovakia, along with some sales offices in Southeast Asia, India, Australia and Europe. So we believe that the purchase can enable us to export -- can serve the clients in region and to better serve the clients in regions. But we are not going to, let's say, shut down the manufacturing site in China, because, in China, over there we already have a pretty solid comprehensive supply chain for the business. So we are not going to shut down any campus in China, but we are just adding some new manufacturing capacity as well as the production base in other countries and regions. So that's the idea for this transaction.

[Unknown Analyst]

So my question is, can you give us more detail on the cost pressure you just mentioned in your presentation?

[Unknown Executive]

Yes, actually we have about 2% drop in our gross -- gp margin. Most of them, I think, they're mostly related to the price increase of raw materials as well as some -- the price increase in passives and some power ICs products. So in order to deal with this issue, actually we have done some renegotiations with our clients. So starting from this June that we may see some -- you will see some price adjustment on some of our products. So for your second question that which is, what are we doing, what are we making for those carmakers? Firstly, we have some power management products and solutions, such as DC/DC converter, on-board chargers. And secondly, we do have some powertrain solutions, including the thresher motors and thresher inverters. And actually, thresher inverter is a device which is the controller of the thresher motor. So basically, the thresher inverter is the motor driver of the thresher motor. So apart from that, we also have a series of EV chargers, including fast -- DC fast chargers and AC chargers, garage chargers.

[Unknown Analyst]

So my question is still on the -- on your transaction with Delta Thailand. So do you have any plans to do any consolidation, I mean, in terms of the maybe sales force or your R&D to do some consolidation with Delta Thailand?

[Unknown Executive]

Okay. Yes, actually Delta Thailand is doing some similar businesses as we do. So traditionally, it's more of -- it was more of the clients' decisions to decide which company they would like to run with. But for the EV charger business, actually in order to make the EV components and products for the clients, the factories have to be certified before you can really making some products for the clients. And the factories in Thailand, they are -- they have been certified by the car audio makers. So they are able to supply the components and products to the car company as well. So going forward, assuming that if we can successfully acquire -- like maybe if we can successfully acquire more than 50% or at least 50%, that -- it is more likely that maybe we can do some reallocate of our capacity. I think the idea is if you need to pay for the tariff, that if you export the products from China, then maybe we can export the products from Thailand. So that's the idea.

[Judy Wang, executive]

So I mean, in terms of the [indiscernible] target, actually, some companies, they may have a pretty good technology or pretty good customer relationships. But if we need to like, let's say, turn around the company because they don't have positive cash flows, I don't think that those kind of companies would be our targets because we still prefer the companies with the healthy cash flow. So as the CFO, I don't think that the financing problem is really an issue for us, especially on this transaction because as we have mentioned before that, we have mentioned earlier that Delta Thailand is actually a company with pretty healthy cash -- operating cash flow. So Delta Thailand alone, it actually has around USD 500 million cash on hand. So combining with the cash on Delta Thailand and Delta Electronics, they're actually combining the cash on these 2 companies, we actually can have like USD 1.5 billion. And also, I think, the banks are actually quite supportive. So I wouldn't really worry about financing issues.

[Unknown Analyst]

Okay, for the second question actually before, let's assume that if we are able to acquire like more than 50% or we can finally own 50% of shares of Delta Thailand, that firstly, before we can consolidated their numbers, so actually, we will recognize the [ posal ] incomes of selling 20.93%, which is the current shareholding -- our current shareholding of Delta Thailand. And after that, we will consolidate their financial numbers, I mean, if we can own like more than 50% of it. So that's the accounting rules.

[Unknown Executive]

Okay. So for your question regarding the IA business, actually, beginning, I mean, starting -- entering into this year, we had actually a quite aggressive target of like, we want to have a -- make a double-digit growth on our IA business. But in the last couple of months, actually, we saw some slowdown in our IA business as well as we saw the same thing in the IA market. I think the main reason is people are -- I mean, the market and the people, they actually have some worries about the ongoing trade wars. So the factories and the factory owners, they are -- they become more cautious on the CapEx investments. Okay, so actually the impact of the trade war is not like -- okay, we actually need to pay for the tariff by ourselves because most of our -- according to our trade terms, most of our products are actually on the FOB basis. But the markets -- or I mean, the factory owners have become more cautious. So I think the only thing we can do -- I mean, the trade war between, I mean, among the countries are far beyond our control, but the only thing we can do as a business, as a company runner and owner, the only thing we can do is we try to enhance our capability, capacity and our flexibility and try to minimize the negative impact from the upcoming trade war. So that's the idea behind this transaction. So you imagine that why we would like to, I mean, made this counter offer for Delta Thailand instead of, like, building some new factories in other countries. I think, considering the uncertainty of this global trade war, we have been searching for a way to do it -- that risk posting -- posted by this ongoing trade war and have been investigating many places for our potential manufacturing sites. But compared to starting over again in a greenfield site, we eventually decided to increase our shareholding in Delta Thailand, the place where they already got a quite comprehensive supply chain there. So I think for the manufacturing, especially for the electronic products, the time to market is a key. So the supply chain, I mean, the comprehensive supply chain is also another thing that -- I mean it's another critical factor in the electronic business.

[Unknown Analyst]

So for this transaction, do you need to get approval from the AGM?

[Unknown Executive]

No, because we are buying the shares through our subsidiary.

[Unknown Analyst]

Can you share some more idea about why the -- I mean, the reason why you do some restructuring on the Delta networks subsidiary?

[Unknown Executive]

Yes, actually we have, right now, we have 150 to 170 subsidiaries right now. So on the one hand, we are -- we continue to buy the companies such as Delta Thailand. So on the other hand, we also need to do some restructuring of our company structure, otherwise -- after consolidating Delta Thailand, that we will have -- I mean, if we can buy more than 50% of it, we will have like more than 20 -- 200 subsidiaries. So we just want to simplify the company structure. Sir, for your question like our investments on the EV business, actually many of those investments went into the testing equipment. And those testing equipments are actually pretty pricey. So right now that we have a big manufacturing base for the EV products, which is in Wujiang plant in China and we also have our R&D center for the EV business in Taiwan. Okay, so for this business that, I think we are -- I mean, we will continue to invest at least for -- we will continue to invest into this business at least for another 1 to 2 years. And during those 2 years that you won't see really significant sales revenues, I mean, from this business. But actually right now, we already have many ongoing projects with most key carmakers around the world. So I think 2 years later that you will see some -- you will start to see some meaningful contribution from our EV business.

[Unknown Analyst]

So within the Infrastructure business, which sector or which business was growing fastest?

[Unknown Executive]

I think that would be -- I think that is our data center solution business because, I think, not only those big data center guys such as Google, Facebook, Amazon they are building their data centers, there are also some other private sectors, such as banks, the operators, carriers, they are building their data center as well.

[Unknown Analyst]

So how long do you think that you need to -- I mean, how long does it take to get the approvals from the authorities?

[Unknown Executive]

I don't really have a concrete answer for that because it's not within our control. But of course, I mean, hopefully, that you can -- I would -- but I hope that this thing can be done like as soon as possible because the longer it takes, the more volatile the share pricing could be.

[Unknown Executive]

So I think she was asking for how should we, like, look at the gross margin profile going forward?

[Unknown Executive]

As I just mentioned earlier that I think that we -- actually I think there was still some -- a little ease in the tight supply channel of the component supplies. On the other hand, actually, we have, I mean, renegotiated with most of our clients. So starting from June to -- starting from June, we will increased -- we have increased some of our -- the price of some of our products. So I think in the third quarter that you will see some -- maybe we can see some improvement in this aspect.

[Unknown Executive]

Yes, so for the [ signature ], I mean on the transaction or the position of Delta Thailand, I think, at least for some of the business, such as the telecom power business, because both of us are doing some similar businesses, so I think that we -- if we can successfully, I mean, acquire over 50% of Delta Thailand, in the future, maybe we don't need to have like 3 R&D centers in Thailand, in Taiwan and in Norway. So I think that we will have some consolidation of our resources after we successfully acquire their shares. Okay, so for our auto-related business, actually, as I mentioned, we actually have engagements with the top 3 carmakers in America and most of the major carmakers in Europe. And we also have some collaboration with some new carmakers in China. So I think the idea for business is we don't want to miss any opportunities because if you miss any opportunities, then you are going to miss the business -- you are going to miss their business for the next 5 to 10 years. So you have to break into the supply chain right now, I mean, at the initial stage. Otherwise then you wouldn't have -- I mean, it's a 0 or -- it's a winner-takes-all nature business. So if you don't have, I mean -- if you don't break into the supply chain right now, then you have nothing in the next 5 to 10 years.

[Unknown Executive]

Okay. For the amortization of this transaction, actually, currently, I still don't have the concrete numbers of it. I think, I mean the normal term is to amortize the intangible assets within 10 years, but the longest one maybe -- you can -- can be amortized, like, up to 15 years.

[Unknown Analyst]

Okay, as you mentioned, and my question is, as you mentioned the auto market is actually a winner-takes-all market, so can I ask for the [ content ] number, I mean how much you can make per car?

[Unknown Executive]

Actually, we don't know the -- how much, I mean, profit we can actually make for a car, but we have some -- we have done some calculation. If we are able to supply all the products we can supply into a car, that it will be like around USD 2,000, I mean the total value for a car.

[Unknown Executive]

So I just wanted to make it more clear regarding the potential impact, I mean, resulting from the trade war on our business because our IA business is actually was [ staying ] I mean, category 1. So -- but even so, the actual number or the actual number -- amount that we need to pay for the tariff is actually not that much. I think the real impact is on the market demand of our products. So for example, when our customers are imposed a 25% tariff, they might have to raise their prices by [ at least like ] 20%. So there will be some indirect negative impact on the market demand and the competitiveness of the products. So I think the real impact is on the competitiveness of the product instead of the real amount that you have to pay, I mean, in our case.

[Unknown Analyst]

So as you mentioned, because it's not on Delta Thai which has to pay for a tariff, but if your client have to pay for tariff, but maybe your client will come back to you and you negotiate the price and want to share some cost pressure with their suppliers which is Delta. So how are you going to deal with those things?

[Unknown Executive]

So I think that's the idea why we made this tender offer on Delta Thailand. We will just try to enhance our accessibility and our manufacturing capacity.

[Unknown Executive]

Okay, so I think the biggest issue at the moment is the global and the international uncertainty, so it's far beyond our control. So I really don't have an answer for that. So I think that's the biggest swing factor on the business. Okay, so for the -- I mean, for our tender offer for Delta Thailand, actually the price we use is based on the average 30 days stock price. So we -- according to the 30 days, average 30-day stock price, actually we have -- we made a 15% premium for this tender. So what I meant about uncertainty is actually you have absolutely no idea what the American government or the China government that they are going to, I mean, to do next because in the first stage, only our IA product are influenced by the category 1. So for the second -- I mean, the category 2, we are safe. But for category 3, actually our networking products, our powers, our IT products and even our solar inverter products are within the list. So there are too many uncertainties that you really don't know that what is really going to happen. So all I think we can do is we try to enhance our flexibility. I think that's the best thing to do to deal with these issues.

[Unknown Executive]

Okay, so actually, Delta Thailand has been in this auto-related business for a long time. So I think because this is -- I mean the EV-related business is actually a new market for everyone. So we do have plans to maybe expand our capacities for the EV-related business going forward around the globe.

So I think [ we are out of ] time. So thank you for [ coming ] today, and thank you [indiscernible].