Asustek Computer Inc

TWSE:2357

Earnings Call Transcript 2018-Q1

[Operator]

Good afternoon. Welcome to the First Quarter 2018 Earnings Conference Call for ASUSTek.

First, Mr. Nick Wu, our CFO, will brief us on the financial results.

[Nick Wu, executive]

Good afternoon, everyone. At the start of the meeting, I would like to express our gratitude for all of you present here. In this age of the Internet, a lot of people are viewing this earnings call online. And we would like to thank all the people present here. Thank you for taking the time to come here. Of course, we appreciate this opportunity to see you face-to-face. Thank you.

Now let's look at the first quarter 2018 -- excuse me, the first quarter 2018 financial results.

The consolidated revenue was TWD 90 billion, down 8% year-over-year. Gross profit was TWD 12.6 billion. Operating profit was TWD 4 billion. Both our gross margin and operating margin went up significantly. Gross margin went up to 14%, operating margin was 4.5%. These were driven by 2 reasons, primarily.

First, on our core business, we continue to improve our product mix and profitability. Secondly, in the first quarter, we benefited from greater-than-expected demand from cryptocurrency. Because of these 2 reasons, we have strong gross margin as well as operating margin in the first quarter.

If we look at the original estimate, it was between 3.5% and 4% for OPM, and we certainly achieved that. In addition, we benefited from the strong demand of cryptocurrency. However, in terms of non-op items, in the first quarter, we recognized about EUR 65 million for preparation of settlement. This was in relation to the European Commission's investigation on our limitation on resale. EUR 65 million is about TWD 2.3 billion. Going forward, all the business units under ASUSTek will work harder for better compliance.

After considering non-op items, pretax profit came to TWD 3.3 billion, net profit TWD 2.4 billion, EPS was TWD 3.2 per share. If we exclude the settlement amount, then the recurring profit was TWD 4.47 billion, up 11% quarter-over-quarter or 22% year-over-year. We are certainly on the right track.

Looking at non-op items. Major items included TWD 300 million in interest income, investment loss of TWD 144 million, primarily from Askey, an investment loss of TWD 505 million. Askey, right now, due to its customer mix and product transition is still going through some headwind. We believe this headwind will continue till the second quarter of this year. Our goal for Askey is that in the second half of the year, we will see more significant improvement. Also, we had about TWD 1.17 billion in exchange gain, other income primarily from the settlement amount with the European Union. Total non-op items came to TWD 760 million for the first quarter of 2018.

Now let's look at the balance sheet for the first quarter. Cash and equivalents TWD 71 billion, inventory TWD 78 billion, compared to the last quarter was flat because the revenue base in the first quarter was smaller, inventory days became longer.

Average days of inventory was 91 days, average days of AR 72, average days of AP 60 days, average cash conversion cycle 102 days.

Now let's look at our revenue by product. PC accounted for 61%, mobile 11%, component 25%.

Region mix. Europe accounted for 34%, Asia 47%, Americas 19%.

Here's our business outlook for the second quarter of this year. For PC, because business tends to be slow in the second quarter, we expect both revenue and shipment to go down by 10% quarter-over-quarter. As for mobile, we're here talking about phones primarily, as new products launch and demand picks up, we expect it to go up 30% quarter-over-quarter.

Component, again, it's a slow season for PC and we will be without the strong demand from cryptocurrency. We expect in the second quarter component will be down 20% quarter-over-quarter. Overall, we believe, in the second quarter, we will continue to improve our profitability and business stability.

We expect, in the second half of the year, as new products launch, as we execute more strategies, we will be able to drive the growth of our revenue as well as profitability. That is our plan so far.

Now I would like to turn it over to Mr. Jerry Shen, our CEO. Thank you.

[Jerry Shen, executive]

Hello, everyone. We are still in a very competitive market.

On this slide, it's about competing with innovation and our agility.

Right now, we want to be better aligned with the world. Here, there are some devices. For example, PC, gaming, mobile, IoT as well as a robotics. These are devices that are important for us. And you can expect products from all of the categories this year. In the core -- in the center of the slide, you see smart enterprise, and there are 3 core technologies, A, B, C: They stand for AI, big data and cloud computing. These technologies can make our enterprise smarter, that's what we are working on aggressively. We call this the smart enterprise. This has been going on for quite some time. Next year, we expect to see even more significant improvement. Based on the foundation of the smart enterprise, we also offer connected services as well as new retail.

These are very important for ASUS going forward because we need to be better aligned with the world.

So this is the core of our business, and we are working hard on these 3 categories. That's what we are doing at ASUSTek. As for PC, this is very similar to the last quarter. We still have ZenBook, 2-in-1 and VivoBook. These products can help us with our brand position and profitable growth. The X Series is about sustaining our volume by attacking. Again, we focus on leading innovation and the Wow experience. And there are 3 parameters in PC that are important for us. First, design or you can also call it fashion; second parameter, performance; third, experience. These are the important parameters we value in the PC business.

The second quarter of this year is going to be the lowest point in terms of revenue. However, in the third quarter and the fourth quarter, after our rework, we believe revenue will pick up. And this is the outlook for PC revenue. Year-over-year, we expect a 5% growth in revenue. As for TAM, the total addressable market, we believe it will only grow between 0 and 1%.

And this is our position building strategy. The brand position and profitable growth products; ZenBook, 2-in-1 and VivoBook, these products will account for a greater share from 17%, 25% to 35%. As for X Series, they will account for a smaller percentage.

In terms of design or fashion, it's about thin, light and narrow bezel. It's highlighted here. It's highlighted here because having a narrow bezel is very important, narrow on 3 sides or even 4 sides. That is the trend to go for both PC and mobile phone. Another factor is to have expressive color on PC products. Also, we value ergonomic hinge design.

As for performance, we want to turn our devices from 2 spindles to 1 spindle to 0 spindle. That is SSD based or PCI based. We will also provide gaming-grade GPU. This is another important factor in terms of performance. We will have more and more products with GPU. Third factor, Optane cache. This is where we work with Intel. You can think of it as a storage case. Optane can really boost performance. In terms of battery, we are offering fast charging. Finally, in the area of 5G, there are 5 -- there are 2 categories; one is millimeter wave, the other is sub-6G. With PC, we are focusing on the millimeter wave technology. And sub-6G technology will be used in a supplementary role.

In terms of experience. First, Windows Hello, Cortana, stylus, incredible audio and cool and quiet. For the sound that we want, we offer incredible audio, for the sound that we don't want noise, we try to minimize noise. These are very important for the user experience. And then Always Connected. These are important factors.

In the area of gaming, it's about both the product and the people. We have the gaming ecosystem hardware. I'm going to talk about the hardware later. We have 8 product lines. We also have a software that connects all the hardware. In terms of people, we have a platform called Join the Republic. We have teams, for example, RW, it's a League of Legends team in Greater China area. We are also building a gaming community. These are the things we are working on, in both product and people.

In our gaming business unit, we are focusing on profitable growth, just as with the PC business. It is very likely that the gaming revenue can be up 10% to 30% year-over-year. It is my hope that every year we maintain the gaming revenue growth in double digits over the next few years. We can certainly expect double-digit growth for this year, between 10% and 30%.

The gaming ecosystem hardware. We have ROG, that's our position builder. ASUS gaming is our volume driver. Products at more affordable prices, whereas ROG is the position builder. And we also offer very comprehensive gaming component offerings. And we also have a business unit on gaming accessories, offering keyboard, mouse, headset, T-shirt, hat, chair, bag, et cetera.

You can think of this as the hamburger and this part is the French Fries. Can you make more money from selling the hamburger or selling French Fries? It really depends. But you need to have comprehensive offerings. So this is what we are offering in terms of hardware. ROG, ASUS Gaming, gaming component and gaming accessory. Aura Sync is a software that offers seamless integration with lighting, with rhythm. These products seems to be vivid, have a vibrancy to them. And all of our products support Aura Sync. This is something a feature that many of our products already have.

Now let me say a few words about the gaming esport lifestyle. We are in several areas, first publishers, leagues, teams, and events. We are working on these different areas. In terms of teams, this is where we see the strongest growth. In addition to products, these are also very important. For example, this part is for live streaming. Actually, gaming-related content accounts for 1/3 of streaming content. And then we have professional teams, amateur teams.

Now let's turn to the next slide. This is our LPL team in Greater China. They just finished the playoffs. In the playoffs, our team was 1 of the top 4. Actually, we came in the third. So our team is going to participate in the Intercontinental Tournament. It's going to be held on July 3 in Korea. This is about the LoL game.

So we have a team which is working quite hard. And I can tell you that the viewing audience of this game is at least, well, in Mainland China, at least, 300 million people.

Now in North America, this is also a LoL team, it's North America LCS team called Echo Fox. And we got #3 in the North America LCS spring playoffs. Also very important, here's our team for PUBG, PlayerUnknown's Battleground. You can think of it as the video game version of Hunger Games. And we have a team for that. This team is in the preparation stage. Later on, it will become an official eSports team. And our team actually participated in [indiscernible] Destiny Cup and our team came out the first. You can see that our teams are all doing quite well. So we are not only competing in League of Legends. Going forward, you can also expect great things from our team for PUBG. And we call this team RWT.

Now let's look at phone, the phone business. First, we have ZenFone 5z and then ZenFone 5 and ZenFone Max Pro.

These are the major products. Max Pro is primarily for India and Southeast Asia. In India and Indonesia, Max Pro is doing very well. It's been selling out for several months. And ZenFone 5 is a is a very comprehensive product. In terms of camera score or photography score ZenFone 5 got more than 90 points.

It also comes with AI features and this was the #1 best-selling phone in Taiwan in April. And this is ZenFone 5z. They have the same ID, but they use different chips. ZenFone 5 uses Snapdragon 636 for balanced performance, whereas ZenFone 5z features Snapdragon 845 for best performance. And this one started selling in April.

In the first 24 hours, we got orders in the to -- of tens of thousands, and whereas this product is selling very well in India and Indonesia. It's been selling out in these markets. For example, the first 12,000 units sold in 24 hours. This one sells for more than TWD 10,000. However, we're able to sell 12,000 units in 24 hours. And this one was the #1 smartphone in Taiwan in April.

In India, in early May, we started selling Max Pro, and this person, this gentleman is the CEO of Flipkart. We have very strong collaboration with Flipkart. We signed an MOU. Flipkart contributed a lot of resources to us, of course, our product is also very good. Within 2 minutes, 30,000 units were sold. That's our performance. And this is a graph from Google trend in India. Here, you see the buzz that this product has generated. The blue line is our Max Pro, whereas the red line represents Note 5 Pro. This is how we are doing in India.

We are also doing very well in Indonesia. Again, this redline indicates Note 5 Pro and the blue line indicates ZenFone Max Pro.

Our first batch contained 4,000 units, and the 4,000 units were sold in 30 seconds. Again, demand is severely outstripping supply. This is a product in the lower Tier, quite affordable and we will start selling this model in Taiwan in June.

In Taiwan, we started with ZenFone 5. In India and Indonesia, we started with Max Pro.

Next, I would like to talk about our ROG phone. We started planning for this model since January 2017. We started the survey in the first quarter of 2017. Now it will be launched very soon. It will be launched at COMPUTEX this year. There will be a grand launch event at COMPUTEX this year. This phone meets all of your needs for gaming. Well, here, I cannot review too much, but we are going to have this ROG phone. It will redefine your gaming expectations. It is a phone and a gaming device.

Since we have a lot of expertise in gaming, we can apply the lessons learned with our ROG and apply those lessons to this phone. This is a high-end phone.

That concludes my presentation today. Thank you very much.

[Operator]

[Operator Instructions]

[Shih-Min Chiu, analyst]

I'm Melrose from Morgan Stanley. Earlier you talked about smart enterprise. You talked about this strategy. Could you give us more color around it? It seems that ASUSTek wants to go from consumer to enterprise? Could you tell us more specific strategies and directions? What kind of products do you have in mind?

[Jerry Shen, executive]

The smart enterprise is the foundation of our company. This is about making us more competitive so that we have a smart brain, so to speak, and a very agile lens. The smart enterprise is about AI plus big data plus cloud computing. When you combine these 3 technologies together, especially with AI and Cloud Computing, and -- your IT system can become very strong. The IT system is like the neuro system of a company. We can give it AI capabilities, big data capabilities and cloud computing capabilities. That's something we are working on. So it is not a product, rather, it's something we are working aggressively on. What I mean by that is as we continue to do this, we will have a very strong foundation for our company. We call it the smart enterprise, because if we want to be aligned with global practices, our enterprise really have to be smart and that is exactly where we are working on. And what do I mean by smart? That is to say, when our employees work on any projects, they can have this IT system as their partner, as their friend. In the past, if you wanted something from the IT system, you have to wait for 3 months or even 6 months and then you could get only a bit of the data that you wanted. That's the traditional model. However, with the smart enterprise, if you want some data, you just talk to the system, the system can carry out a conversation with you. This is what we are implementing. Our employees can talk to the IT system, the neuro-network of the company. And through these conversations, our employees can be more efficient and more effective. The smart enterprise is to improve the overall competitiveness of our company, to make our employees more efficient. This is not directly linked with a product.

[Shih-Min Chiu, analyst]

Earlier you said that as ZenFone 5 was launched, demand has been outstripping supply. So the question is what's your outlook for profitability for the phone business?

[Jerry Shen, executive]

What we're seeing right now is that we have 5 and 5z as our higher-end products and Max Pro is our mid-end product and Live is the lower-end product. Now we are seeing the strongest performance with our mid-end products. Very strong in Indonesia as well as India. And 5 and 5Z are also doing well. Now let me start with the mid-end product. With the mid-end product, to my estimation, right now it all depends on the supply chain, and we are enhancing our supply chain. Whatever the supply chain can supply, we can sell those models. We can sell those units, so I think the out-of-stock problem may continue for a while. This is not because we did not planned for enough. Actually, the demand has been much stronger than expected. Having said that, I believe, in the third quarter we can see the volume really shooting up. As for 5 and 5Z, when we launched these projects in Taiwan and they sell for over TWD 10,000 and they are very well received by consumers in Taiwan, they are very satisfied with our camera functions, our design and our AI features. We can expect that ZenFone 5 will have great sales performance in the third quarter. Overall, we can be quite optimistic for the phone profitability in the third quarter. People usually think that only Samsung, Apple and a few Chinese phone makers can be profitable. However, it is our hope that in the third quarter we can really break that stereotype. Of course, the third quarter is not here yet, but it's coming soon and we believe we can break that stereotype.

[Unknown Executive]

Okay. So the first question is from Arthur Liao from Fubon Security, he wants to know why Askey has still loss and when will we see a profit in 2018? Askey?

[Jerry Shen, executive]

As for Askey, in terms of its operational performance, we are expecting better performance. We've been looking at its major business units, and the efficiency and gross margin, operating margin of the business units. We've been intervening quite extensively. By the end of this month, we are going to do something, that is, we are going to invite the Askey team to come and make a report to the Board of ASUS. That is to say, we are not yet satisfied by this current performance, but we are working very hard to turn Askey around as quickly as possible. Today in our board meeting, we made a resolution that we are going to ask Askey to report to our Board. That is something we are already doing.

[Nick Wu, executive]

Any other questions from the floor or from the Internet?

[Jianfa Wei, analyst]

I'm the analyst from Yuanta, my name is Calvin. In the first quarter, you recognized TWD 2.3 billion in preparation for the settlement. Is there an opportunity to offset that amount? Or that's simply a write-off?

[Nick Wu, executive]

Well, let me talk to you about the background. Last February, EU initiated an investigation, specifically about limitation or agreement on reselling prices. The investigation involved 6 to 7 companies, of which ASUSTek was one of them. Our legal team and our sales team were very cooperative in the investigation process. We prepared data and information from our company for the review of EU investigators. Right now, the investigation has come to a conclusion, and we recognize that we probably need to prepare for a settlement in the amount of EUR 65 million. Indeed, that amount is significant. But that is also something that we have to accept. The most important thing is that going forward, in terms of our training, in terms of our procedure, we need to strive for better compliance. We need to better understand and better execute EU regulations. We don't think such an incident will occur ever again. When you run a business, of course, you encounter surprises. What we can do is to put the resources and procedures in place for a better management to minimize such risks. That's my answer to your question.

[Jianfa Wei, analyst]

The revenue in April has not been very satisfactory. I understand products transition is one factor, but people are also speculating, perhaps that is because the value of bitcoin went down, so the demand for GPU also came down. Was that a big factor?

[Nick Wu, executive]

Let's talk about cryptocurrency for a moment. This a new demand or a new industry, if you will. Indeed, in cryptocurrency, the demand can be quite volatile. It's difficult to predict. However, if you look at a longer horizon, it is indeed a new industry where computing power is required. According to some research analysts, cryptocurrency may account for 5% to 10% of computing demand. Some companies even say that 5% or 10% of the [indiscernible] capacity this year is to meet the demand of cryptocurrency or blockchain. So if we take a long-term view, we can say that in the short term it's not -- it's easy to predict the demand from cryptocurrency. However, if you take a longer-term view, because cryptocurrency requires computing power. So cryptocurrency is going to have a positive impact on ASUS. If we want to build a financial model or we can say is that on top of our core business, perhaps cryptocurrency can add a mid-single digit benefit to us, in terms of our profit. That's just a factor, however, in our planning and strategy, we, of course, focus on our core businesses, such as laptop, phone and motherboard. Those are our main concerns. But we seize opportunities whenever they arise. We will leverage the demand from cryptocurrency. We also want to leverage our position in graphics. When the opportunity arise, of course, we try to maximize the value for us. Now back to the revenue in April. The April revenue was relatively low. First of all, indeed, the second quarter tends to be a slow season for PC. As CEO mentioned earlier, in the second quarter, the demand for our phone outstripped our supply. So now for the second quarter, our strategy is that we want to enhance our product mix and we want to enhance our operation stability. We want to provide growth and momentum. And in the second half, we are going to see new products. Also, the second half is traditionally the peak season for the industry. So in the second quarter, we want to build a stable foundation and we can expect better momentum in the third and the fourth quarters. That's our thinking.

[Jianfa Wei, analyst]

A follow-up question. People have been talking about the shortage in raw materials. The shortage has been severe. Is that having an impact on ASUS? Whether it's PC or smartphone production? So what materials, what components are in shortage?

[Jerry Shen, executive]

In the second quarter, the shortage problem is primarily with our phone business, because now we are expecting greater volume. The demand is far greater than our plan. Demand has been very, very strong, so we cannot get materials in a short notice. Right now, we are experiencing shortage in some small parts; for example, camera parts. As for PC and other business, I think the situation is all right. So while we are still experiencing shortage is in the phone business.

[Jianfa Wei, analyst]

People have been talking about passive components. What are their impact on ASUS?

[Jerry Shen, executive]

If you are an OEM or ODM manufacturer, perhaps you'll be more heavily impacted, because passive components account for a greater percentage of your cost. But for us, a brand owner, the impact is relatively controllable. Yes, I understand the prices of passive components have been going up and up. So the other day I asked my colleague, so the share price of [indiscernible] is it over TWD 100 now? No, it's way over TWD 500 now. But in terms of our supply of passive components, yes, the supply is tight, and we also see a bit of monopoly in this space. However, in terms of supply chain management in this area, we're doing quite well.

[Jianfa Wei, analyst]

Lastly, we understand that gaming is going to have great performance this year. We understand also that in the third quarter NVIDIA is going to launch a new platform. Now for this new platform, are you going to have strong products on this platform? And what are your expectations?

[Jerry Shen, executive]

In April, Intel launched Coffee Lake and we were the first to launch a product to the market and time to volume as well. And we are very aggressive in the gaming space. We are a leader and we have improved a lot. I believe we will keep our leading position. And when new products come out, they will impact the volume. They will also impact the ASP. In the third quarter, compared to the second quarter, I believe we can see a pretty good growth, at least double digit.

[Jianfa Wei, analyst]

Now my last question is about GPU. GPU prices went up quite significantly in the first quarter. So what's your take on the third quarter ASP? And when NVIDIA launched a new product, the base will be high and ASP will also be higher. Will that have an impact on sales?

[Jerry Shen, executive]

Yes, indeed. The ASP has been going up quite a bit, at least twice the original price. With our VGA, we actually fulfill 2 demands; one is mining, the other is gaming. GPU can be used for these 2 purposes; one is gaming, the other is mining. As the value of bitcoin -- actually, right now bitcoin mining can be done on ASIC, for example, from TSMC. Now what's having an impact on GPU is Ethereum and the Ethereum price has bottomed out. Going forward, cryptocurrency may be less volatile. So the volatility from the cryptocurrency space will be smaller than before. As for our graphics card, we primarily focus on gaming, and mining is only secondary to gaming. Of course, the strategy can have a greater impact when mining is very popular. But when mining is not so popular, the strategy also can minimize the impact on us. Now we will address a question from the Internet.

[Unknown Executive]

This question is from KGI, Angela. She wants to know the company's first quarter in 2018, the OPM has surpassed 4%, almost to 4.5%. Will the company still expect to target the OPM for over 4% in the upcoming year or set a higher target?

[Nick Wu, executive]

Regarding OPM, due to regulation, we are not allowed to comment on a target, what we can share though is the past quarter. During the first quarter, our OPM was 4.5%. That was better than internal as well external expectations. If you look at the reasons behind that, originally we expected OPM between 3.5% and 4%, and also second reason is that we benefited from the strong demand from cryptocurrency. These 2 factor combined gave us an OPM of 4.5%. If we set mining demand aside, if we look at our core business, in the second quarter, we believe, we will see a very stable growth. In the second half of the year as new products are launched and momentum is created, it is our hope that in the second half of the year we will see stronger operating margin. The demand from mining can be very volatile. So we will just treat it as an additional upside. When the opportunity is there, we, of course, seize it. But if the opportunity is not there, it does not affect our overall business strategy. That's my reply to your question.

[Unknown Executive]

Second question from Angela what's the earnings contribution from gaming notebooks and components in quarter 1 of 2018?

[Nick Wu, executive]

Again, we are not able to give you a detailed breakdown on that. We can talk in very general terms. Gaming contributes more than 20% of our revenue. In a normal product cycle, in a normal scale, it may account for more than 30% of profitability in the PC business. As for component, it has been offering us stable profitability. It's been a very stable foundation for ASUS.

[Jerry Shen, executive]

As for gaming-related complement, especially motherboard, gaming contributes quite a lot to the motherboard business, probably over 20%, while VGA benefits both from gaming and mining. I cannot give you more details.

[Nick Wu, executive]

Let me add. We have very comprehensive offerings in terms of gaming. We have component, PC, motherboard, graphics card and monitors and displays. If you pull this offerings together, you can see that in the gaming space, we are the #1 leader. And, of course, our goal is to consolidate our leading position.

Are there more questions from the floor?

[Operator]

Thank you very much for your attendance. This concludes our earnings conference.