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Good afternoon, everyone. Welcome to Delta First Quarter 2018 Investor Conference. For today's analyst meeting, I will have to leave earlier as I will be going to represent the company to collect the Presidential Innovation Award at the Presidential House at 4:00. So I will have to excuse myself at 3:00. But our CEO and CFO will stay and continue to answer all your questions after I leave.
So firstly, we will still have our IR manager to report the financial numbers of Q1.
Okay, so thank you for coming. Before we start, I still need to remind you that all the financial numbers are reported based on IFRS, and the consolidated numbers have been reviewed by CPA as well. Now we will review the financial numbers of Q1. Q1 revenue was TWD 50.9 billion, up 4% Y-o-Y, but down 17% Q-o-Q where about 2% was coming from the consolidation of VIVOTEK since October 2017.
Sequentially, we saw a seasonal decline in each segment, with Power Electronics declining faster than the other 2 segments, with the soft demand in PC and smartphone.
Year-on-year, we saw the strongest growth from Automation segment. Meanwhile, Infrastructure was also growing nicely. However, even with the pretty fast growth of automotive business, Power Electronics as a whole was still under some pressure with sluggish demand in computer and smartphone applications. And therefore, continued to shrink its size. So overall, the mix was shifting more to Automation and Infrastructure compared to a year ago. Gross margin in Q1 was TWD 13.0 billion, down 2% year-on-year and 21% quarter-on-quarter. Similar to previous quarter, our gross margin was still under some pressure, including pricing pressure on traditional power supply business as well as the cost pressure from rising material prices, with inflation as well as heavier depreciation. Considering the above-mentioned headwinds, gross margin in Q1 was squeezed a little bit to 25.6% by the pricing pressure and the increasing cost.
Given the unfavorable scale in Q1, R&D expenses as a percentage of sales increased to 8.3% from 7.3% in Q4 and 7.6% from a year ago. There was a 13% increase on year, but part of that was because of the acquisition of VIVOTEK. Likewise, with the smaller scale, SG&A as a percentage of sales increased to 11.8% from 10.3% in Q4 and 11.5% from a year ago. So the OpEx number in Q1 was TWD 10.2 billion, representing a 5% decrease quarter-on-quarter, but 10% increase year-on-year. Again, with the unfavorable scale, just expenses ratio hit a new high at 20.1% in Q1. So other than the inferior gross margin, since we have been increasing our investment into R&D, sales channel as well as our own factory automation, our OP margin has become more sensitive to the revenue scale because of the higher [ fiscals ] now. And therefore, ratio-wise, OP margin in Q1 decreased to 5.5% from 9.4% in Q4 and 8.1% from a year ago. Here, we provide some breakdown of operating profit by sector for your reference. As mentioned earlier, the profit contraction of Power Electronics was largely related to the heavier pricing pressure on the traditional power supply business as well as the increase in cost pressure from [ many space ]. Besides, even though the growth of automotive business was quite strong in Q1, the faster it grew, the more loss it made as it's still a business hungry for capacity expansion in order to meet the customers' requirement of mass production. So in Q1, we had about TWD 1 billion nonoperating profit. We had TWD 3.8 billion profit before tax, which was down 25% year-on-year and 42% quarter-on-quarter, due to the contraction of operating profits.
Our EBITDA in Q1 was TWD 6.6 billion, which was down 10% year-on-year and 29% quarter-on-quarter. Q1 tax expense was about TWD 863 million, representing a 23% effective tax rate. The increase of noncontrolling interest compared to a year ago was from the consolidation of VIVOTEK. So the net profit after tax in Q1 was TWD 2.8 billion. So our EPS, first quarter EPS, was TWD 1.07.
I have 2 questions here. The first one is related to your gross margin, as we all know that your gross margin in Q1 was 25.6%. I wish to know how much impact is from the cost pressure.
Okay. For your question, I would say that actually, there were multiple reasons for the inferior or shier gross margin in Q1. But if you really -- if you are asking me there which one of these reasons or factors impact -- has the biggest impact, I would say that probably the pricing pressure from our traditional PC applications because we got a little bit squeezed from the pricing pressure of our PC application as well as the increasing cost pressure from the material prices.
Do you see that there is any chance that we can see the gross margin resume to, like, 27% level in the first half?
I think the biggest challenge for us right now is the transition. Our goal and our strategy is always transform ourselves from the lower-margin business to the higher-margin business. But on the way to the eventual successful transition or transformation, we will get squeezed before we successfully shift our business to higher-margin business because the lower margin or the legacy business, or the profits there, they are declining. In first quarter, some of our peers, they were doing pricing war in the traditional business, for those kinds of, like, PC applications. But I don't think that can be sustainable. So also, for the second quarter, the scale will be bigger. So I would tend to say that the first quarter shall be the lowest in terms of margin for the whole year.
This is Sharon from Morgan Stanley. As you just mentioned, we were facing some pressure, pricing pressure and also cost pressure in the first quarter. But for your IA business, if I'm calculating right that your OP margin of -- the IA OP margin in first quarter was about like 14%. But actually, in the past, your OP -- the IA's OP margin has always been like 15% level. So I would like to know how should I look at the OP margin trend of IA going forward.
Okay. So if you compare to the previous quarter, I think the decline of IA OP margin was largely related to the scale. But if you compare the OP margin of IA in first quarter to a year ago, I think those -- they are similar to each other.
So can you give us more detail regarding the material price inflation? How will you do with that?
I think the passive market was under growing -- was undergoing a consolidation phase right now. So there were -- there was some imbalance between the supply and demand in the passive market, so that was the reason of the material price inflation. But eventually, I think the demand and the supply of passive components will reach a balance at some point. Of course, we will try to negotiate with our customer to see if there is any chance that we can raise our prices. But actually, that's quite difficult. But we are -- we will still -- we will keep trying that. Your question regarding the Chinese company, ZTE, was prohibited to -- by the components from any American suppliers. Actually, I have heard that we -- they reviewed our portfolio or our exposure to ZTE, and we found out that we don't have, actually, we don't have so much -- we don't have too much exposure to ZTE. But for another Chinese company, Huawei, that we do have, like, larger exposure to them, but at most just like tens million dollars business. It's actually not that much. So we should be okay, and the risk should be manageable.
This is Samson from HSBC. Okay, so my question is, do you have any plan for your expenses control?
Yes, I think that everyone is pretty concerned about our expense control. I think we tend to control our R&D expenses at the current level, which is 7.5%, and that's our goal.
If it's okay to ask, you mentioned that we are actually in the middle of a transition process, but your legacy business was actually shrinking much faster than the growth of your new business. So do you have any strategy to deal with this or to protect your profitability of your legacy business?
Actually, for the question -- for your question, the growth or the profitability of the legacy business is actually subject to the market. Yes, so for demand of the legacy business is actually subject to the market. There is not so much things we can do with that because when the market is getting mature, that everybody is suffering there. But the things we are doing is, actually, we make many efforts shifting our focus, resources from the traditional business or traditional applications to the new applications. For example, we shift or we relocate our R&D engineers -- engineering people from developing the traditional PC powers to other applications trends, such as medical powers, industrial powers. So that's the things we are doing now.
So how do you see the cost pressure, especially from the material price going forward?
So according to our internal forecast, the second quarter should be better than the first quarter because of the scale and the operating leverage. So there is the chance that we can see the resume of our margin in the second quarter and the rest of the year.
So my concern is that actually, there are more and more new players trying -- into the industrial automation market as well as the EV chargers market. So do you think that you can still maintain your profitability in those 2 areas going forward?
I think that our strategy for IA is quite clear, that we are not only selling the -- we are not just selling the components, but also selling the -- we also try to sell the whole systems or the whole solution. And we just have some good news regarding that, and we can share to you that actually, we have -- we just have done a project for a Japanese company for making the whole production line for their motors. So for those kinds of production line automation -- actually, we are making money from 2 layers: one is from their -- one is from selling the components to customers; and the other is from selling a knowledge of the -- selling that knowledge and -- and selling the whole system to the customers. Then for your concern that there are more and more new players trying into this market, actually, like about 2 years ago, we did sell some -- or did see some new names on the market. But this year, when I reviewed our competitive landscape, some of them, they just vanish and disappear in the market. So that is not about that there are more and more competitors taking part in the market, it's about how many of them they can survive in the market. So our focus is always about the sustainability and how to survive in the market for a long term. So the things that we are doing to achieve that goal is by -- we try to produce every component or the most components of IA in-house. So we got, like, at least 70% of components for the -- of the solution desk that we are selling to our customers. And also, other than our knowledge of system integration and our own components selling, the service and sales channel is still so critical in this market. You need to be able to serve your client in a timely basis whenever your client have some issue on their production line. So I think that in that sense, we are on a good base. And for the other business, the EV-related business, actually, like almost everyone in this market are still figuring out the successful business model here. I'm sorry, I can only answer, like, one more question then I will have to leave -- no, sorry, I think that I still need to excuse myself here because I can't be late to the Presidential House.
Sir, do you have the breakdown of the power business in first quarter?
So actually, we can go back to this page. So you can see the biggest decline is actually from the Power Electronics segment. And the Automation segment is doing okay compared to a year ago. And the Infrastructure remains quite stable. Of course, there were some cost pressures in every segment, but those 2 segments are doing quite okay. So the things in Automation are a little bit different from the business model in the PC market because there are no, like, a super big client, like a big name in the PC markets. So I think that outlook of Industrial Automation will continue to be quite stable because actually, this result of and outcome of many small clients is not just about one client, and the client is doing bad or good, will have a huge impact on the business. So I think that part will be stable, and you shouldn't be too worried about that.
Can you share more detail on your wind power business as well as your Building Automation business?
Okay. For the wind power business, actually, we are not doing the engine part. We are doing the power conversion for the wind power infrastructure. But even the Taiwanese government, they are planning to build more wind power stations in the near future. But because, actually, the Taiwan market, the scale of Taiwan market is still quite small, so I don't really think that that can contribute or they can make a, like, significant contribution to our business because our scale -- total revenue scale is much bigger than that. I think that for the Building Automation business, we are still in the process of integration of those companies we just acquired in the past 2 years. And because we are still in the process of integration, so the revenues of this segment continues to grow. But the profitability, we still need to make efforts before we can see some significant profit contribution from the Building Automation. But for the Building Automation, actually, we are seeing it as our branded business. So for this kind of branded business, that it takes time to build up your sales trend now, your service network. So I think that it still takes some time to see this business contribute to a significant part of our sales. But I'm quite optimistic to the outlook of this business in the future.
So when -- my question is when will we see that VIVOTEK, the one you just acquired, the company you just acquired last year, when will we see the successful or the fully integrated -- integration with your current Building Automation business?
My answer is it takes time to achieve that because, like, 70% of VIVOTEK is from ODM business. And -- but we just acquired VIVOTEK in Q4 of last year, so it still takes some time to fully integrate them into our business or into our company. But we do start selling some -- I mean, the bundle business with -- to our Building Automation customers.
So your question is why that Infrastructure segment. The growth of infrastructure segment in Q1 was about 5%, but the profitability -- the growth of the profitability was just about 1%. My answer is that is because of -- that was because of the mix of the segment because the lower-margin business in that segment grew faster than the higher-margin business in Q1. So that's why. So I may not be that clear about the specific project of each business, as you mentioned that whether we have chance for the, like, specific project. But I believe that our salespeople and our BG head, they should have noticed that opportunity that if we have that opportunity, we will definitely work for it.
My question is, how is it going on the Eltek side? And how is Eltek doing?
Okay. I think that Eltek is actually doing quite okay. We acquired that company in 2015. And then it is part of our ICT infrastructure segment right now. I think the revenue -- I mean, the revenue growth was okay, but it still needs some time to see the bottom line improvement, I mean, compared to our expectation, to our original expectation for Eltek. And the things we are doing is we are still in the process of integrating the factories and sales office of both sites. Once we successfully integrate our sales network and all the facilities, then I believe that we shall see the bottom line improvement.
So when do you see 5G will really takes off -- will really take off?
Okay. So for -- I mean, as my -- as far as my understanding, the technology of 5G is actually -- the technology of 5G will be higher frequency but lower penetration. In that case, that we will see -- we shall see higher volume of the powers but lower output of each power supply.
Do you think that we can -- I mean, for -- as a Taiwanese company, that we can be beneficial from this 5G CapEx cycle?
I think the technology of 5G hasn't been really finalized yet, so it might be too early to say whether we can -- or how much we can benefit from this CapEx cycle. But of course, there will be more opportunities for us for our telecom business. But it's hard to really quantify there how much we can benefit from the 5G CapEx cycle.
Actually, our brand product for telecom or for 5G CapEx cycle is actually our telecom power, which is doing a power conversion for the base stations.
So how do you see the outlook of your IA business as well as your, like, say, component business for this year?
Okay. So for the IA market -- actually, we see IA business as our branded business. We had -- we have only very little ODM from -- we have only very little revenue from the ODM business in IA. So for this business that we have been working on in, like, for over 20-some years that -- we started by making our own components. And after we have a pretty comprehensive component portfolio that we start -- we started making our system products such as our robotic arms. And then after that, we started doing the whole solution for our customers. So in that case or in that -- for that business, actually that we believe there is still a lot of room for us to grow in the IA market because we are still actually a small guy or a small player in that market. So I will be -- I am not worried about that.
So how do you see the, I mean, the future of the outlook of your passive component business, especially on the Power Electronics side?
For those high-end smartphones, actually, they -- the pattern of that is actually, they -- the customers, the high-end smartphone customers, they will need to, like, retrofit their platform, like, every 2 to 3 years. So our subsidiary, Cyntec, has always been working on that, like, for developing the new platform for the high-end customers. So of course, but I mean, even if there's still some room for us to improve or to grow in the high-end smartphone market, but we do have this discussion about whether we should penetrate into the lower-end smartphone customers, that we do have this discussion and we are thinking about this because the margin or profitability there will be lower, but volume there will be higher, too. So that's possible.
So maybe then we will have a last question from you guys.
Yes, I have 2 questions here. Okay, my first question is, I know that we are quite clear about your long-term strategy, and we do appreciate that. But recently, especially for your first quarter result and your first quarter stock performance, both of them were quite weak in the first quarter. So will you have any strategy to deal with or any thought to deal with this kind of short-term headwinds? Will you do anything different?
So for the first quarter results data, actually, there were, indeed, there were plenty, like, different kind of headwinds, which result in weaker performance of our financial results. But we still believe that those kinds of headwinds, they are relatively short term. Actually, the things or the thoughts in our mind is we are always thinking that -- where will be the opportunities or the growth opportunities going forward in the future? We are also -- that is always something that in my mind that our answers for that is we believe that the EV market, the IA market, the Building Automation market and also the Smart Greenmarket will be the next growth driver and growth opportunity for us. Indeed, that's quite challenging for us to manage so many kinds of different businesses at the same time. But we have determined to expand our portfolio into this [ about ] management segments. And that's the things we have been doing right now. So I am quite clear about our long-term goal and strategy and the things we are doing, and I'm quite confident about that. But for those kinds of short-term headwinds, actually, there are not so many things that we can do with that. So the only things that we can do is we need to stick to our plans and our strategies, and we'll further improve our execution. But we can start by doing the things we are doing right now because if we believe that it is the right thing to do, we need to stick to the strategy and our plan.
I know that -- I mean, if the power supply business -- I mean, for the PC, notebook applications, has always been highly competitive and high. So -- but in the old days, the delta can always protect your margin and profitability in that kind of competitive market. So -- because I know that the product quality for your power supply is always the -- almost the best, I will say, in the market. So even if your prices are higher than your competitors, the customers will still be willing to buy the products from you, so that's why you can maintain your profitability there. But as we all know, that there is some change in your profitability or some contraction in your profitability for the PC and notebook application power supply. So is there -- are there anything different in the market? So -- or did you do anything different compared to what you have -- what you did in the old days?
I think that our Chairman has answered this question before. Some of our competitors, they cut their price like just ridiculously in the first quarter as well as the past 1 year. But I don't think that that is a normal thing to see because no one can be sustainable in that kind of a business model. Even they won the orders and projects from the customers with lower quotations, but once they can fulfill their orders, they still need to give back those orders they have won from the customers. So I don't think that is something normal. So I think that for the long run, eventually, we will see the balance in the market even for the legacy of our supply business. That's my answer.
So thank you for coming today, and that's our whole conference meeting. Thank you.