Asustek Computer Inc

TWSE:2357

Earnings Call Transcript 2017-Q4

[Operator]

Good afternoon. And welcome to the Fourth Quarter 2017 Earnings Conference Call for ASUSTek. First, Mr. Nick Wu, our CFO, will brief us on the financial results.

[Nick Wu, executive]

Good afternoon, everyone. First, let's go over our results for the fourth quarter of 2017. At the end of fourth quarter, the consolidated revenue was TWD 104 billion, down 0.2% quarter-over-quarter. Operating profit, TWD 3.97 billion, up 33% quarter-over-quarter. Net profit was TWD 4.05 billion, down 31% quarter-over-quarter. This was mainly due to that most of the cash dividends were recognized in the third quarter. EPS in the fourth quarter was TWD 5.4 per share. The operating margin improved from 2.9% in the third quarter to 3.8% in the fourth quarter. This was mainly due to our effort in product mix optimization and better sales management. During this period, we've been focusing on improving our profitability and control our profitability. On the other hand, revenue remained flat during this period.

Right now, we still focus on improving our profitability. Basically, the results we're seeing right now are on the right track or even better than our targets. Overall, it's been a very positive trend.

Moving on to non-op items. In the fourth quarter, interest income was around TWD 220 million. Investment loss around TWD 210 million, mainly due to our subsidiary Askey, which we recognized about TWD 455 million of losses in the quarter.

Askey had a lot of long-term orders. So it was more subjected to fluctuations in component prices and forex fluctuations, which exacerbated their losses. Askey has come up with improvement plans. They will improve on their orders and management.

It is expected that in 2018, Askey will show substantial improvements. Exchange gain in the fourth quarter was TWD 963 million. Overall, total non-op items stood at TWD 1.11 billion. Looking at the balance sheet. At the end of the fourth quarter, cash and cash equivalents was around TWD 67.4 billion in a very healthy and normal range.

Inventories, TWD 76.1 billion, down 10% from the previous quarter. Cash conversion cycle was 94 days at the end of fourth quarter. Specifically, days of inventory was 82, days of AR, 68, and days of AP, accounts payables, 56.

Look at the income statement for the entire year. The net revenue was around TWD 393 billion, down 8% year-over-year. Operating profit was TWD 12.5 billion, down 28% year-over-year. Net profit was TWD 15.5 billion, down 19% year-over-year. EPS for 2017 was TWD 20.9 per share. Indeed, in 2017, we at ASUS encountered some turbulences in our operation. We're faced with fierce competition and some negative factors impacting the entire industry, for example, component prices increases and forex fluctuations. In the second quarter, we experienced a trough of an operating margin of 2%. However, after that, ASUS quickly adapted. We optimized our product mix, and we strengthened our sales management.

In the third and fourth quarter, the operating margin actually went up to 2.9% and 3.8%, respectively. Overall, ASUS is on the right track. During this process, during this transition, our priorities have been to increase profitability and better profitability stability. So the revenue remained flat. And this will continue till the first and the second quarter of 2018. Later, we will have new product launches, which will drive revenue and profit growth. That is our basic outlook for this year.

In terms of major non-op items, in 2017, we had very stable interest income exchange gain and dividend income. We showed a loss -- investment loss. As mentioned earlier that was due to Askey. With Askey's effort we expect, in 2018, we'll see significant improvement in this area.

Now let's look at the revenue mix in the fourth quarter. PC contributed 63%, mobile 15%, component contributed 19%, thanks to higher demand from gaming and cryptocurrency. IoT accounted for 3%. Regional mix. Europe 38%, Asia 40%, Americas 22%.

In terms of the revenue mix throughout the year, PC accounted for 63%, mobile 17%, component 18%.

This slide shows the business outlook for the first quarter. For our major businesses, including PC, mobile and component, we expect the revenue to be down 10% quarter-over-quarter, with a range of plus or minus 2.5%. There are several factors. First, the first quarter is a traditionally slow season for the PC business. Also, year-to-date, NT dollar has appreciated quite substantially with -- in a lot of uncertainty. Our priorities remain to increase our profitability and stable profitability.

So far, NT dollars has appreciated by 5% compared to the same period of last year. This had an impact on our revenue and profitability calculation. However, this is still within the manageable scope. The business outlook numbers that I just gave you have factored in these considerations. In view of the forex uncertainty, overall, this outlook is quite reasonable and healthy.

That concludes the presentation on financial results. I would now turn it over to our CEO, Mr. Jerry Shen. Thank you.

[Jerry Shen, executive]

Good afternoon, everyone. My opening slide remains the same. It's all about innovation and the speed of transformation, that's how we can win the battles. As for the second slide, there has been some slight changes. Here you see our main businesses. Going forward, through these devices, it is our goal to provide the connected services. You can also call it a data-driven enterprise, or to paraphrase again, it's a smart enterprise. A smart enterprise is, of course, data-driven. It also has everything to do with AI, whether it's the operation of the business or the IT system, the information system, we need to strengthen our enterprise, so that our enterprise can be a agile and smart one. So that's the title of this slide, the Smart Enterprise. That is our goal to be more agile and smarter. Through strengthening the use of data, we aim to provide the connected services. This is a concept that we proposed last year. We didn't achieve greatly last year. However, starting from this year, we will really enter the era of the connected services. We will be very aggressive and proactive. Now, what do I mean by connected services? Of course, they are closely associated with data, AI. They're also about making our enterprise a very flexible one.

We can be data-driven in terms of our decision making and client engagement. Slowly, but gradually, we will move from devices to connected services.

A few words about our PC business. There are 3 aspects. First, is about design, or we can call it fashion; next, performance; and then, experience. In terms of product categories, we have 2 major categories. The first category is all about brand positioning and profitable growth. Within that, we have 3 subcategories: ZenBook, 2-in-1 and VivoBook. And then the other category is all about volume driver, that is our X Series. How can we sustain our volume?

We need to sustain the volume by attacking. So on the one hand, we will maintain the volume with X Series and then we grow the share with the categories on the left. While the industry will have a growth between 0 and minus 5%, our goal is to achieve a greater than 5% annual growth.

The X Series will maintain a certain volume, and the category on the left will grow. For example, ZenBook, 2-in-1 and VivoBook, altogether accounted for 17% in 2016 and that figure has went up to 25% in 2017 and our target for 2018 is 35%.

There are some key points about fashion. It's about thin and light, and narrow bezel, whether it's 2-, 3- or 4-sided narrow bezel, expressive color and better hinge design. These are the key points to the fashion dimension. In terms of performance, we want to go to 0 spindle that is to replace mechanical hard disks with solid-state discs.

So 0 spindle is one approach in the performance dimension. Another key point is to bring gaming-grade graphics to mainstream laptops. And then with cache, we are offering the Optane cache. Point number four, fast charging. These are all about performance.

Moving on to experience. A few features we're offering, for example, fingerprint and instant face login. These are offered by Windows Hello. You can unlock your laptop with your fingerprint, or facial recognition, as with your mobile phones. Cortana, voice assistant, that is very important. Stylus, and then our devices will offer great performance while remaining cool and quiet.

As part of the experience, we want to enhance the user experience. Another feature is to offer the Always Connected PC. These are some of the key points in terms of experience.

Gaming. Most of the time we've been focusing on products. We now have 8 product lines, which I will briefly introduce later. In addition to products, we also need to have an ecosystem and that has everything to do with people. For example, our eSports teams, our community, these are all related to people. So on the one hand, you have products, on the other hand, you have people, or you can call it ecosystem. Under people, we have Join the Republic. It's a platform. It's very similar to a talent show, where unknown players can be discovered. You can transform a nobody into a somebody if you will. Right now, we have quite a few projects in this category.

And then we are forming gaming teams. For example, in China, they have the East Division and the West Division, just like NBA. And now, the team we sponsor in the East Division is ranked #2. Later on, they will participate in the national championship. Community is also very important.

In terms of hardware, hardware can be considered as our fundamentals. We will continue our efforts here. First, ROG, this is how we build the ecosystem. Then there is ASUS Gaming. It's our volume driver. We not only want to have premium positioning, we also want to pursue volume.

Then there is gaming component, including motherboard, VGA, display and router. We will further solidify our efforts. We will also leverage the open platform. A new addition to this ecosystem is gaming accessories. These are very important to the community. Devices, such as keyboards, mouses, headsets, T-shirts, hats, chairs and bags. Gaming accessories are going to be an important part of our ecosystem.

So 4 parts to the hardware.

In terms of software. We have a software called Aura Sync, which controls the rhythm of the LED light displays. The devices seem to be breathing. These devices include motherboards, displays, mouses, laptops, VGA cards, networking devices, keyboards and desktops.

With Aura Sync, we can control the pace and rhythm of the light. When the light is on when the light is off. Because of this, these devices will look like they're breathing, and this is a consistent look across different gaming devices. We've brought this feature to almost all of our gaming products.

Next eSport lifestyle. There are several important elements in the eSport lifestyle. First, publishers are important. Then leagues, events. Number four, teams. Some people may wonder what do teams have to do with hardware. Actually, right now, the devices that we are selling right now, we will continue to sell them, and we will also support teams as well as forming our own teams. We work extensively with publishers.

With gaming, live streaming is extremely important. And these games are broadcast, and you can charge the broadcast licensing fee. And you can also sell tickets. You can think about the NBA model and replicate it here. Live streaming is very popular on the Internet right now. And gaming accounts for 20% of live streaming content. In other words, gaming takes 20% of the live streaming industry. Gaming is very important. Then there are leagues, the gaming leagues. Here, primarily we are working with Tencent Games. This has been announced. Tencent has 14 teams in China, 7 in the East Division, 7 in the West Division. We are sponsoring a team in the East Division. It's one city, one team. Again, just think about the NBA model, it's the same for this gaming model.

Right now, our team in the East Division is already participating in the spring season. With this gaming league, there are 2 seasons per year. We have many fans within 1 month of the team's establishment.

Events. We have Join the Republic as the platform. We will discover talented players in Taiwan, China. We can work with schools and industry partners, and organize events, inviting amateurs to participate. If they are skilled enough, these amateur players can turn pro. They can become professional eSports players.

The events can cover both amateur ones as well as professional ones. This is Riot. This is the publisher of LoL, League of Legends. And another very popular game is PUBG, PlayerUnknown's Battlegrounds.

You can think of League of Legends as a basketball game and PUBG as a football game. These games will enjoy popularity for decades to come, and different games have different ecosystems. Okay. This is our Join the Republic platform, from Zero to Hero, providing players a path to fame.

This is our team in China. They are called Rogue Warriors. That's their logo right there. And these are our team members. This team is ranked #2 in the LPL East Division. Our team has already participated 7 out of the 24 games. At the end of the season, #1 from the East Division will play against #1 from the West Division and the national champion will play in the international championship.

Within 1 month of the team's establishment, we've already recruited 90,000 fans. They are in the age bracket of 10- to 15-years old. It's a different segment that you can reach. So that was in China. In the U.S., we also sponsored this team. This team performed #1 in LCS, Echo Fox. ESports are being added to the programs of the Olympic Games and the Asian Games. Pretty soon, we will also form a team in Taiwan. In 3 markets, we will form teams. In Taiwan, China and the U.S., we will have teams, and we will spend more effort in these 3 markets. In the rest of the market, we will sponsor clubs.

Moving on to the Phone business. Between 2015 and 2017, we focused on one goal, that is to increase our average selling price.

In 2014, our ASP range was TWD 4 to TWD 6. By 2017, the range became TWD 4,000 to TWD 15,000. Starting from this year, we will maintain our price range. The range of TWD 4,000 to TWD 15,000. This is a healthy range. And our focus this year is to drive volume.

This year, out of our product lines, we'll be on schedule. Last year, product launches only started in the fourth and the -- in the third and the fourth quarter. So that represented a bit of headwind. In the coming MWC, Mobile World Congress, at the end of this month, we are going to attend and have a product launch there. The product launch will be attended by some of our industry friends, for example, the President of Qualcomm will also be there.

We are going to announce our Zenfone 5Z, featuring Snapdragon 845, and this one will use 636, this one as well. This year, our product launches will begin in March. With an earlier launch schedule that will be tremendously helpful with winning market share. And this is my last slide. This is 5. We expect a spectacular launch at MWC, and this year once again, our goal is to maintain our ASP and further drive the volume.

That concludes my presentation. Thank you very much.

[Operator]

[Operator Instructions]

[Arthur Liao, analyst]

This is Arthur from Fubon. First question, the gross margin in the fourth quarter was worse than that of the third quarter. I understand that the operating margin was better. I'd like to understand why? Traditionally, the fourth quarter has been good for ASUS. So what's the reason behind the numbers we're seeing today?

[Jerry Shen, executive]

The product mix in the fourth quarter was very similar to that of third quarter. We got similar contributions from PC, mobile, et cetera. Several factors include the forex fluctuations. In the fourth quarter, NT dollar appreciated significantly. Another factor is our sales management approach. Sometimes, we offer discounts directly instead of spending more marketing dollars. Sometimes, we needed to adopt different strategies, due to different market situations. We need to strike a balance between revenue and marketing expenses. Overall, we managed with an eye on the operating margin. And in the fourth quarter, indeed, we have achieved a good result with our operating margin.

[Arthur Liao, analyst]

With PC and mobile, the first quarter guidance is down 10% quarter-over-quarter. However, the PC business doesn't look so pessimistic this year. What's your take on this?

[Jerry Shen, executive]

Most of the research would point to a decline in PC business. However, we see some ODM companies, such as Quanta showing better results.

[Arthur Liao, analyst]

In the past, the first quarter PC business would show a decline of 15%. So could you explain the reason behind the number? Has the PC business bottomed out?

[Jerry Shen, executive]

I think primarily, the guidance reflects the NTD exchange rates. There will be a 5% decline because of the exchange rate, because outside Taiwan, in other markets, we quote in U.S. dollars. So that will have a impact on our financial numbers. Secondly, the interest of our product lines in the PC business, we think the volume will remain flat. Now we are running business units. These business units are all about pursuing profitability and maintaining the brand image. And at the corporate level, we will have some "targeted attacks". With this strategy, we believe our volume will remain flat and the revenue guidance we have given is a conservative one. So the global PC market will not be too bad. The industry growth rate will be between 0 and minus 5%. And our goal is to have a growth rate of between 0 and 5%. In addition to maintaining our profitability, we will also have targeted attacks, so that we achieve a 5% growth. Looking at the first quarter numbers, in terms of volume, I think we are getting close to our target.

[Arthur Liao, analyst]

Last question. If the mobile business will be on schedule this year, can you give us better guidance in terms of gross margin and operating margin for 2018? If the PC market isn't too bad and your mobile launches will be on schedule, can we expect better performance than last year?

[Nick Wu, executive]

Well, let me first talk about revenue. This year, our goal is to maintain our ASP and positioning with our mobile business and grow the volume. Most of the product launches will be in the second quarter. However, last year we only launched products by the end of the third quarter. So this year, we are moving 6 months earlier. And that can be a boost to our revenue. In terms of the mobile business, there is one market that is particularly difficult. That is the China market, and the second difficult market is India. And the rest of the global markets are doing quite well. In China and India, you do need to spend resources to fight the battles there. We expect our revenue will be heavily influenced by the mobile business revenue. And we are giving you very conservative outlook.

[Arthur Liao, analyst]

Will gross margin be closing in on 14% or better than last year?

[Nick Wu, executive]

Actually, we cannot comment directly on the numbers. What we can say is that last year, ASUS encountered some turbulences. We are still in the process of adjusting. We are now healthier. In the short term, revenue momentum may not be strong. We will maintain our focus on profitability improvement. ASUS is a company that is pretty much driven by product cycles. In the second quarter, in the second half of the year, perhaps we can give you a better operations outlook. We expect by then, we can look at better growth.

[Patrick Chen, analyst]

This is Patrick from Nomura. A quick question. When you give the outlook for the first quarter since we are in mid-February already. Now you are giving us this range. Is that range reflecting the forex uncertainty or the uncertainty about the end market, you are adding some buffer here, so to speak?

[Jerry Shen, executive]

In the mobile business, usually, the third and the fourth quarters are transition periods for mobile. In the first quarter, we will be conservative about mobile numbers. As for PC, after reorganization, we see results at the business unit level. And then, at the corporate level, we can launch, "targeted attacks". But right now, we are only giving very conservative numbers.

[Patrick Chen, analyst]

Next question is about gaming. As CEO mentioned earlier, we are now moving to the mass market. I believe other PC brand companies are also adopting the same approach. What's your take on this situation? Is that reflecting the fact that gaming and eSports are more mainstream now? Is that a positive development for you? Or perhaps it represents more competition? In different situations, what is ASUS' competitive edge compared to your competitors? What's your winning edge?

[Jerry Shen, executive]

In the gaming space, I would like to talk about products and the ecosystem. First, let me talk about products. Indeed, the revenue is now coming more and more from the mainstream products. However, in the gaming space, even the mainstream mass market products still sell for 1.5 to 2x the price of regular laptops. Inevitably, we will see mainstream products contributing more to our revenue. With our ROG product line, it's still quite stable. But we're seeing greater growth from the mass market products. Seeing the situation, we have 2 different series, ROG versus ASUS Gaming. With our ASUS Gaming, we're quite good at innovation and cost control. We've established a new business unit. I'm talking about notebook and PC. After our internal evaluation, we do believe, we have the wherewithal to succeed. For example, in April, Intel is going to announce its 8th generation CPU. We will be the first company to adapt that to incorporate that into our products. Our competitive edges include innovation and our speed to innovate as well as cost control. We believe we can succeed in this area.

[Angela Hsiang, analyst]

This is Angela from KGI. In the second half of last year, you started the restructuring. And it looks like that you're seeing improvement in the fourth quarter. Earlier, it was mentioned that the restructuring would take 4 quarters. Now, are you on track or are you moving faster according to your plan? Can we see the 4% operating margin coming back this year?

[Nick Wu, executive]

Let me take a stab at this first. It is our goal that our operating margin will be over 4% in the third quarter. Again, the process will take about a year. I think we are moving faster than our plan. As the 4% operating margin, you mentioned, that is also my target as well. We aim to achieve it by the third quarter.

[Angela Hsiang, analyst]

Could you tell us the most meaningful change you've implemented during this period?

[Jerry Shen, executive]

First, internally, I try to talk about the value stream. Products are most important for us. Communication is also key. Communication is more effective now. We have product road maps, and we moved the schedule earlier. In the past, marketing people only took over after a product is developed. Now marketers get involved much earlier at the end by -- of a product development cycle. Say, product development cycle takes 6 months. Marketers start to get involved in the discussion 6 months earlier. In addition to that, our marketing people can also come up with the theme or the marketing strategy. So our marketing-oriented discussions also start 6 months earlier. That gives us more time for communication. We can have more communication about the value stream. All the discussions are happening at a much earlier stage. That's the first change. Second change. We now have business units. Most discussions are conducted at the business unit level. At the corporate level, we play the support role. We can have relentless discussions, to fine-tune our strategy, to better compete. Business units are taking the beat, and we, at the corporate level, we launched "targeted attacks". And that gives me a greater advantage point. Those are the major changes.

[Angela Hsiang, analyst]

So these changes have an impact on your cost structure or expenses?

[Jerry Shen, executive]

With the notebook business, if marketing and salespeople only get involved after a product has been developed that's not going to be profitable in certain countries with certain products. However, if we can adapt to the situation 6 months earlier that makes all the difference. So the bigger difference is our response time. It's now 6 months earlier. All the core teams within the business units will be involved in the discussion. And the sales and marketing people, they understand the market very well. They are very sensitive to the market situation. They can respond much faster. This makes all the difference. So the biggest difference is perhaps this pace.

[Angela Hsiang, analyst]

Second question. I don't know if you can share the number. But last year, what was the ballpark figure of your smartphone sales?

[Jerry Shen, executive]

Last year, the smartphone business was rather tough.

[Angela Hsiang, analyst]

Could you give us the loss range? What about this year? Do you expect to turn this around or maybe you have a better target?

[Jerry Shen, executive]

With smartphone, my target this year is to prove that globally in addition to Apple and Samsung, and the 4 Chinese phone manufacturers, there is another company that can grow and be profitable at the same time. So that's my goal this year. To maintain the ASP and maintain our profitability. Last year, the product schedule was rather late, in late third quarter and early fourth quarter. So in the first and second quarters, we suffered losses. But in the fourth quarter, the loss has been minimized. We are moving in the right direction. Our goal this year to prove ourselves. Worldwide, we have the 4-plus-2 players, the 4 Chinese players, plus Apple and Samsung. Our goal is to prove that in addition to these 6, we can also be another company that achieves profitable growth.

[Angela Hsiang, analyst]

Earlier you mentioned the price range is now TWD 4,000 to TWD 15,000. But that is a very credit space. What are your key competitive edges? For example, you mentioned that you have earlier product cycle. But in terms of product, how do you plan to differentiate yourselves from your competitors?

[Jerry Shen, executive]

Internally, we talk about the 4 dimensions of products. First, quality; second, cost; third, speed; fourth, innovative values. Quality is only revealed after 6 years of a product launch. However, quality is the most important element of our brand. Without quality, there is no brand. However, quality is a given. So I'll only talk about the remaining 3, cost, speed and innovation. At ASUS, after the reorganization, we have about 1,500 people in our mobile team. With such a lineup, we can deliver the 3 important elements, which are inherent in our ASUS DNA. We can compete on those 3 elements: innovation, speed and cost. As for quality, that is a must for a brand company.

[Angela Hsiang, analyst]

Earlier you said that the notebook business will grow faster than the market. What about gaming? Can you comment on the gaming unit targets or expected sales growth?

[Jerry Shen, executive]

As I said last time, with the establishment of a new business unit, we are closer to our goal. The gaming business is very fast and operating quite well. My target is double-digit growth.

[Angela Hsiang, analyst]

You mean, revenue growth? Okay. Now we are going to have a new COO. Could you tell us the responsibilities of the newly appointed COO?

[Jerry Shen, executive]

Well, he's been a good friend of mine since 1998. He's been a good friend. I've asked him to join us for several reasons. First, to provide us the strategy. He has the skills to run a large company. He can help us with the strategies as well as tactics. He can be helpful with establishing good systems and practices as well. If we are going to run a new business, there is still room for improvement in terms of our company practices. For example, in addition to business units, where strategies or tactics are needed, we also need to fine-tune the practices at our functional units. Since we have international operations, it is important that we also have international practices. I myself had a R&D background. I don't have enough experience in the areas that I just highlighted. So I've asked him to come onboard to help us develop more forward-looking products. There are 3 categories. First, the ecosystem. Within the ecosystem, we will focus more on IoT and gaming. Secondly, new retail. We will focus on new retail. Thirdly, smart enterprise. These are our new approaches. With our existing products, he can provide a different perspective on strategies and tactics, and he can also help us with our functional units.

[Operator]

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

[Jerry Shen, executive]

Thank you very much.