Asustek Computer Inc

TWSE:2357

Earnings Call Transcript 2018-Q3

[Nick Wu, executive]

Ladies and gentlemen, thank you for joining us online for the investors conference call for 2018 Q3.

First of all, we will present the financial results for Q3 and then the business outlook for Q4. If you have any questions, feel free to key in your questions at the bottom right-hand corner of the screen, and we will address your questions at the end.

Now please turn to Page 5 of the slides. This shows the income statement for Q3 of 2018. For 2018 Q3, the net revenue amounted to TWD 93.8 billion, which shows a growth of 16% Q-on-Q and a decrease of 10% Y-on-Y.

The operating profit was TWD 2.24 billion. The net profit was TWD 3.34 billion, which is a loss of 43% year-on-year. This translate to an EPS of TWD 4.5. Overall in Q3, the operating pressures come from a decrease in profit margin, and this includes a number of unfavorable factors, including the U.S.-China trade war amounting to large fluctuations in currency in the emerging market. Also, many chip providers in Q3 have the issue of lack of supply or slow supply. In addition, we faced a number of pricing pressures from our rivals. Therefore, in Q3, we faced a number of operating pressure.

Overall, ASUSTeK, in Q3, have initiated our mid to long-term strategy and prediction. In terms of our efficiency and competitiveness, we will work on mid to long-term planning and work on the execution of our operating plan. We expect that after a period of time and during this period of time, we will pursue operation stability. As for the improvement in operations, we hope to see this in our next production cycle, which is about in mid-2019 or the latter half of 2019.

Now let us turn to Page 6, our non-OP items. Our interest income in Q3 is TWD 298 million, with a loss of TWD 496 million in investment income, and this is a result of a loss of TWD 777 million from Askey. The operations of Askey is currently still in transition, and they face, obviously, the U.S.-China trade war in Q3 and Q4, which means that production capabilities may face relocation and will affect production. We hope that Askey will continue to improve in terms of operations, and we expect that in the latter half of 2019 to see more concrete results. We see a loss in ForEx of TWD 280 million, and that is because of currency issues. Also, we have a much larger gain in dividend income, which is roughly TWD 2.48 billion. This comes from other income, which is about TWD 1.8 million. Our other income amounts to TWD 171 million.

Now turning to Page 7, which is our 2018 Q3 balance sheet. As of September, our cash and equivalents amount to TWD 62.4 billion, which is a slight decrease over last quarter, and this is because in our Q3, we have paid out our cash dividends of TWD 15 per share which roughly translates to TWD 11.1 billion. Also September included high demand season and a large number of days in inventory, so we see an increase in both these area. So overall, the average cash conversion cycle in Q3 was 96 days.

Next, I would like to turn your attention to Page 9, which is a breakdown of revenue by product. PC accounts for 62%; mobile accounts for 16%; components account for 18%. We can see that components have fallen from Q2 to Q3, and that is because the demand for cryptocurrency mining has fallen. In Q3, cryptocurrency has amounted to a very low level in demand.

On Page 10, we can see the breakdown by region. In Q3, Europe accounts for 27%; Asia accounts for 51%; and the Americas, 22%. Europe has fallen compared to Q2, and this is a result of high pricing competition among our rivals.

On Page 11, this is our business outlook for Q4. We expect that PC shipments in Q4 will be flattish Q-on-Q. Our mobile products, we expect 0 to 5% growth. And for components, because we are facing low demand in Q4, so we are looking at 0 to -5%.

Overall, looking at the industry situation in Q3 and Q4, we faced the U.S.-China trade war, we faced shortage in chip and solution providers, and we faced pricing competition among our peers. So therefore, we will in Q4 in terms of revenue, we expect to match Q3. We face many uncertainties in Q4, and therefore, we will use a cautious and flexible attitude when facing these uncertainties.

Next, I will turn over the presentation time to our CEO, Mr. Shen.

[Jerry Shen, executive]

Ladies and gentlemen, next, I will introduce, in Q3 and Q4 and in the future, our plans in ASUS. First, in terms of products, we will continue current operations in our products, our PC, mobile and gaming, also in terms of IoT and AIoT. Also, robotics is part of AIoT. We view this as our future products. And finally, we hope to provide connected service as our ultimate goal.

Second, when looking at our future strategy, we need to look further. I have organized our ASUSTeK business as current business and future business. As for our current business, we need to sustain current business. As for our future business, we need to catch and stay on top of future trend. This is our two-pronged strategy.

In terms of our current business in SWOT analysis, our strengths lie in design, innovation and talents. We are one of the few brand companies that focus very much on cultivating our R&D talents. So design and innovation are our main strengths. We also look at our weakness in scale. Because we focus more on consumer, we lack this ability in scale. Also, ASUS culture, we want to promote agility and in terms of our response time to change. In terms of opportunity, we feel that gaming is a very -- this is a very comprehensive operation, so this includes desktop, notebook, VGA, networking, RG keyboard, all these accessory and even in terms of our eSports teams. We have made a lot of progress in this area, and we feel that in the future, gaming will play a big role.

In terms of threats, we have 2 large external threats. One is the pricing pressure that we feel from our competitors. The U.S.-China trade war will have a very large impact, especially on ForEx. This will obviously impact many of our trading partners such as China, Russia and Indonesia. The ForEx impact will be sizable, and this poses a lot of risk in terms of hedging. Also, we face the Intel CPU shortage. Starting in Q3 and continuing to Q4, we will face an ever-growing shortage. This will obviously contribute to our uncertainty in terms of component production. And third, we face price pressure from our peers, especially in the Europe region.

In order to sustain our current business, the important thing is to focus and to build value added. After all, ASUSTeK's strength lie in innovation and design. So we need to provide value-added products.

Our research team is very important in this consumer-focused era and how to create better products. Also, ASUS cares very much about recruiting top-quality talent. We need to reduce OpEx. Because of the lowering of profit margin, we need to control OpEx in a better way. And finally, in terms of profit, we need to keep the bottom line. Of course, profit comes from price times quantity, and so we need to care about both of these factors.

In terms of future trend, these 3 aspects were not an important part of our operations before, but we feel that this is a trend and this is a great opportunity for Taiwan and it's also a growth area for ASUS, for us to be in line with global trends. The first is providing connected service. The second is AIoT, which is AI and IoT, and the third is AI cloud computing. These 3 aspects are interconnected. And ultimately, ASUS wishes to provide connected service to provide the best service for our consumers, to provide active service for our consumers.

That is my presentation for today. We are not fully satisfied with our results in Q3, and we hope to do our best to provide better results in Q4. Obviously, there are lots of variables facing us in Q4, such as the U.S.-China trade war. Therefore, our forecasting ability for the future is not great. Perhaps in the past, we're able to forecast with accuracy more than 50%, but now, we may only be able to forecast 20%. So we face many challenges. Thank you.

[Nick Wu, executive]

Thank you. We will now proceed to the online Q&A segment of today's conference call. Because of the online nature of our conference call, we face a 30-second lag, so I hope that you will be patient and log in your questions on this page. Thank you.

[Unknown Executive]

First, our question comes from Fubon. Can you please explain the situation with the Intel CPU shortage? When will it be resolved? Would it be resolved in Q2 or Q3 of 2019?

This situation has a few different aspects. We cannot answer on behalf of Intel. For example, data center would be the priority for Intel shipment. And obviously, this priority is not something we can answer on behalf of Intel. The shortage would affect component levels the most, such as the motherboard. Currently, we believe that before Q2 of next year, this will not be resolved. Perhaps it will be resolved in Q3 of next year. So from now to next year, we face many uncertainties in terms of the CPU shortage. Second would be the effect from the U.S.-China trade war. The most immediate effect would be from ForEx fluctuations. Many of our partner countries we may have to hedge 0.5% per month, which amounts to 1.5% per quarter. And if you do not hedge risks, you may face 10% to 15% per quarter, which is a huge impact compared to our slim profit margins. Second, we face tariffs in terms of our productions, which may affect the third aspect, which is to relocate our production from China. This is something that all producers have to face in terms of component level and open platform. We may relocate from China to, for example, Taiwan or Vietnam or other countries in Southeast Asia. These are all candidates for relocation. During relocation, we hope to maintain our product competitiveness. Now obviously, some of this relocation is more urgent such as component level, whereas system level may be less urgent. Third, in terms of raising prices. If we are the leader of the market, this will depend -- if we are the leader of the market, we have the ability to determine pricing. However, companies which are not leading the market can only follow the leader. So it is very difficult for us to raise prices in U.S. and Europe markets. So in order to raise profitability, we still must focus on our innovation and design, and these are our strengths and the ways to resolve consumers' needs. Also innovation and design provide a lot of motivation in boosting sales. So compared to other brands, we at ASUSTeK feel that there is more space for us to improve in innovation and design.

Let us pause for a moment while we organize some of the questions we are getting online. Let us continue with the next question from Goldman Sachs. Can you please elaborate the profitability of mobile phones and future outlook?

In terms of profitability in mobile phones, we focus on value-added products or focusing on niche markets such as the ROG market. In large-scale markets, ASUS faces immense pressure. Therefore, in the future, we will reassess our mobile products. So by carrier and in China, we have shifted our business away. Also in terms of our mobile business, we need to look at focus and value-added market. So we will center our market in these areas. This is our strategy and direction for Q4 and next year.

Our next question is from KGI. What is the proportion of commercial PC and consumer PC? Do you expect Windows 10 upgrade to trigger enterprise demand in 2019?

Currently, commercial PCs or commercial notebooks account for very little, around 10%. In the future, we aim to increase this. In terms of operational reorganization, we hope to create a dedicated business unit for commercial products. Therefore, we hope that in Taiwan, China and the Southeast Asia, we hope to make bigger inroads in consumer products. As for commercial products, we focus more on Chromebook in U.S. and in Europe, such as England and North Europe, we have a commercial market. Therefore, in terms of region and in terms of products, we focus on consumer products in Taiwan, China and Southeast Asia. In terms of commercial products, we focus on Chromebook in U.S. and Europe. The proportion of commercial products is about 10%, which is relatively low, and we hope to increase this ratio quarter-by-quarter.

The next question is from Nomura. What is the earnings contribution and year-on-year growth on gaming-related products in this year? What do you expect the growth to be in 2019?

Currently, the earnings contribution for gaming-related products is roughly 15%, and we hope to boost this to 20%. In gaming, we touched on this in my presentation, we focus on system products, components, eSports teams and accessories and we have committed a lot of effort into this. In gaming and the commercial products, these are high-growth areas. Although these are low-range gaming products, we face higher pressure. But we hope that in gaming-related products, we can more comprehensively develop this sector. In the future, we will combine ROG and gaming into our mobile phone products.

The next question is also from Nomura. What is the reason for higher tax rates this year? And can you comment on the range in 2018 and 2019?

The biggest reason is the amendment of Taiwan tax laws, from 17% to 20%. This is reflected in our prediction for our tax rate. ASUSTeK has a number of overseas branches and operations. Therefore, we predict our revenue tax, our business tax to be within the range of 22% to 24%, and this is for your reference.

The next question, how does the trade war between China and U.S. impact ASUS? And what is the sales contribution of components from the U.S.? What is the strategy or adjustment on the supply chain?

It will first affect revenue, but it will have a smaller impact. It will also affect our profit, which has a bigger impact, especially in terms of ForEx fluctuations. In terms of products, this will have a smaller impact on system products now. However, this may change in the future, and we may need to adjust our production sources. However, ForEx fluctuations will have a bigger impact on motherboards and VGAs, especially if tariffs also affect it. So in Q4, we are more urgently dealing with the impact on motherboards and graphic cards, whereas in Q1 and Q2, we may make some systematic adjustments.

We will continue to organize our questions online.

The next question is from Citibank. Will ASUS sustain the cash dividend payout policy?

In principle, in Q3 of 2017, we had undergone a reorganization and announced our policy on cash dividend payouts. We are committed to cash dividend of TWD 15 per share in the next 2 years. So in 2018 and 2019, we will uphold our commitment, which is TWD 15 per share. Looking towards the future in terms of cash dividend policy, we are looking at a dividend payout ratio of 60% to 70%. As to whether we will adjust this on a yearly basis or to provide a more stable cash dividend policy, we need to have internal discussions and the agreement of our board before announcing further. But we can say for sure in 2018 and 2019, which is probably around June or July of next year, we will maintain TWD 15 per share cash dividend payout.

Regarding loss on Askey, how do we see this company in the future and how is ASUS handling the situation?

I would first like to report that Askey is currently in transition. Originally, it used retail, and now it is transitioning to direct sales to the consumer. This involves the investment of resources into new applications such as 5G and smart home applications. And because of this transition, in the past 2 years, it faced a number of operational pressures. ASUS has been in discussion with Askey leadership and has asked Askey to reduce operation costs and focus more on certain areas. In terms of future direction, we support Askey's operational transition and investment in new areas. We will continue to work with Askey leadership to help the company to be more stable and more effective. We hope that in the second half of 2019 to see more concrete improvements from Askey.

The next question is from Nomura. What is the market acceptance of the price increase of notebook-related products in the second half of 2018? What is the growth rate of notebook shipments this year compared with the industry? And can you comment on the PC industry and goals of the company for next year?

In notebooks, I will discuss it by region. In the Southeast Asia region or China or Taiwan markets, these markets are relatively stable. In the U.S. and Europe, we face larger pricing pressure. As for the increase of the price of the products, we have had a number of internal discussions. If we simply raise prices based on the original model, we do not feel that the market can bear this. So after discussions with our sales representatives, we feel that by improving the design of the product and the innovation of the product, only then do we have the margin to increase prices and to counter pressures from ForEx fluctuations. Therefore, it doesn't work to simply raise prices, therefore, we have worked hard on product design and innovation, which the market would be more willing to accept. As for whether to raise prices by region in Taiwan, China and Southeast Asia, we face less pressure, and in U.S. and Europe markets, we face greater pressure.

The next question is from Goldman Sachs. Why can't ASUS offset the Intel CPU shortage by using more AMD solutions?

I believe that each company is considering using AMD solutions to offset the Intel CPU shortage. However, we must consider the acceptance of AMD solutions by country or region. Certain countries and regions have a higher acceptance. Therefore, we will offer alternative AMD solutions. Countries and regions with lower acceptance, we will continue to provide Intel products. Of course, internally, we are considering using AMD amid the Intel CPU shortage. But in terms of region, we need to consider their level of acceptance.

How are tariffs on components, motherboards and VGAs being absorbed? Are they being absorbed through ASUS, the supplier or raising end pricing? And how is it being shared?

ASUS, faced with the trade war, we have very quickly provided solutions and faced lower pressure in this area. However, in terms of the CPU shortage and the reduced demand for cryptocurrency, this has created a greater impact on our motherboards and VGAs. So we need to use operational solutions to resolve this. Therefore now, components are more impacted by the CPU shortage and lack of demand for cryptocurrency.

Our next question is also from Goldman Sachs. Why is pricing pressure more severe in Europe and the U.S. rather than in Asia?

This has to do with our consumer model. In the U.S. and Europe, because of its traditional retail model, it is more like a conventional warfare. 80% of its market is in retail, and thus, it faces greater pricing pressure. In China, Taiwan and Southeast Asia, we face more like a guerrilla warfare, where products are sold one by one, individually, and we face lower pricing pressure. If you have differentiation in design or pricing, you can differentiate from other products. Because of the transparency in pricing in Europe and the U.S., therefore, we face greater pricing pressure.

The next question is from Citibank. Does the decrease of key component prices make a positive impact on gross margin?

The lower prices will make a positive impact on gross margin, but it only has a short-term impact, within 1 to 3 months. However, lower prices result in a bigger problem in purchasing because the bigger the scale, the more expensive the price. With lower costs, scale means something. So in key components such as DRAM, storage, panels and others, lower prices means that bigger scale brings bigger risks. Although they may have a positive impact on the short term, but once it balances out, we face greater pressure in the long term.

If you have any questions, please key in your questions. Thank you. The next question comes from Yuanta Securities. When can we see positive Y-o-Y sales growth?

Based on our observations, other than the pressures and competition faced by the PC market, the cryptocurrency cycle is also a big factor. The cryptocurrency cycle peaked around the third quarter of 2017 to the first quarter of 2018. Therefore, in Q1 2019, we will see a rather large Y-o-Y comparison, which is a downside. ASUS hopes that with a new product cycle, we can increase shipment and competitiveness as well as a better position for our products. Therefore, we need to wait for the new product cycle, which will roughly fall on Q2 of 2019 or the latter half of 2019. Therefore, we hope that around this time line, we can see positive Y-o-Y sales growth.

As demand in cryptocurrency declines, will the motherboard and VGA business move towards AI and blockchain?

In terms of VGA cards, obviously, we are developing gaming products. As for AI and blockchain, we are making progress in this front as well. In AI, we are using internal solutions as well as external solutions. AI is obviously a major trend. Blockchain, although it is not yet mainstream business, it is also trending.

The next question is regarding phone business. The competition is intensifying from leading companies. How will ASUS position the phone business?

I have mentioned this previously in my presentation. Our phone position will progress towards niche markets, and we will avoid highly competitive regions and industries. So we are avoiding China and U.S. carriers. In terms of products, for example, ROG is a niche market and niche product, so our phone business is also undergoing transition. Therefore, our ROG business will contribute greatly to our brand.

The next question is from DIGITIMES. How does the Intel CPU shortage impact gaming notebooks?

The shortage has to do with order down. And in Intel's value chain, I believe that gaming notebooks has a higher position. Obviously, I cannot say for sure what their value chain is, but gaming and commercial products should be just below data center in terms of their priority.

The next question is from an investor. The net asset value is low. Does ASUS consider share buyback?

In our consideration, we will look at the actual value and whether it is reflected in market value. We will look at several factors, including our long-term value and market valuations and whether they are undergoing great fluctuations. If several unfavorable factors exist at the same time, including low valuations, lower than the company's actual value or if during the short term, there are fluctuations in company operations, we feel that in terms of company finances, we may offer suggestions. And after discussion from our board and consideration of all factors, we will do the best for our investors.

Our next question. Regarding suppliers moving out of China, what is your expectation on the shifting based on discussion with your suppliers? Can you comment on the proportion of China and non-China production and your target?

In response to this question, I will base it on a qualitative consideration. We can look at the supply base as China, Southeast Asia, for example, Vietnam, Indonesia and India, and the third is Taiwan. So we will be shifting suppliers through these 3 areas based on cost, time and other factors. So choosing between China, Vietnam, Indonesia, India and Taiwan, we will select the best production model for ASUS based on qualitative considerations. Thank you.

Currently, there are no other questions online. And therefore, we conclude today's investor conference call. Thank you.