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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Ladies and gentlemen, welcome to ASUSTeK 2019 Second Quarter Investor Conference. Today's investor conference is divided into 2 parts. First CFO Nick Wu will present the financial results. Then Co-CEOs S.Y. Hsu and Samson Hu will present business highlights and strategy and outlook. Then we will have our Q&A session. Our guests online can key-in your questions through the question tab. Thank you. Now let's welcome CFO Nick Wu to present the financial results.
Thank you. Let's look at Slide 5. Here we have presented ASUSTeK 2019 Q2 brand P&L. In 2019 Q2, net revenue was TWD 71.3 billion. This is slightly lower than expected mainly due to the U.S.-China trade war in Q2. This has affected the demand and inventory adjustment in China. Gross profit in Q2 was TWD 9.9 billion. The gross margin is 13.8%. The improvement in gross margin comes mostly from improvements in product mix and reflects partly the reduced costs in components in Q2. In Q2, operating profit of non-OP Items is 10 billion (sic) [ TWD 1 billion ], with an operating margin of 1.4%. This is a total of net profit of TWD 1.68 billion in Q2 with an EPS of TWD 2.3. On Slide 6, we have the 2019 Q2 brand P&L. We have shown separately our old phone models and new phone models. So excluding our phone P&L, for 2019 Q2, our net revenue is TWD 65.4 billion. Operating profit is TWD 2.0 billion. Operating margin is 3.1%. This reflects that we have made improvements in our operations in PC and components. Looking at Page 7. This is our brand non-OP items. In Q2, total non-OP items is TWD 1.2 billion. Including TWD 330 million in interest income, TWD 140 million in investment income and TWD 311 million in exchange gain. Furthermore, in Askey, we have a loss of TWD 57 million, which is much smaller than the loss of TWD 612 million of last year. We also anticipate that Askey will continue to improve and adjust operations, which will be more accurately reflected in our financials in the second half of this year. In the second -- in the first half of 2019, we have an exchange loss of roughly TWD 160 million, but we can also see that in Q3 there are some larger changes in the U.S.-China trade war which will affect currency and exchange rates. In Q3, the exchange rates will affect our revenues from China as well as our positioning and management of renminbi, so we maintain a cautious attitude. In Q3, we also anticipate a large cash dividend income of TWD 2.25 billion. This has already been confirmed by our shareholder meeting and will be paid out in Q3. On Page 8, we can see our brand balance sheet. Most of our items maintain a very balanced position. We have cash and equivalents of TWD 61.7 billion, accounts receivable TWD 63 billion, accounts payable TWD 42 billion. And as of the end of June, we have TWD 75 billion in investments (sic) [ inventories ] versus TWD 80.8 billion in Q1 of this year and TWD 79.4 billion of last year. It is a little bit lower. Q2 is a lower base period for our operating expenses. Therefore, our average days of inventory is 116, which is relatively higher. Looking at Page 10, our revenue mix for Q2. PC accounts for 70% of our products. Components and others account for 30%. By region, Europe accounts for 31%, Asia 46% and the Americas 23%. In Asia Pacific, especially in Southeast Asia, our operations are constantly being adjusted and improved. On the other hand, the instability and volatility in demand have counteracted our growth. On Slide 11. This is our business outlook for Q3. We expect PCs to grow by 20% quarter-over-quarter; and components, notebooks and VGAs, to grow 15% quarter-over-quarter. Overall, we believe that, ASUSTeK in terms of operation adjustment, we have seen a lot of positive growth and development, including product innovation, inventory and sales channels. We have made several improvements in these aspects. However, in our larger environment, we have to face the U.S.-China trade war and the uncertainties that it brings. Also we face competition from our peers in the PC industry. We believe that our company's development is on a positive trajectory. However, we may not see the actual benefits and results until after a long time. Finally, we hope that our company can maintain a stable and high-quality dividend policy. Today, our Board, after discussion, has confirmed that in the next 3 years we expect to pay out at least TWD 10 per share per year. Each year, the cash dividend amount will be confirmed by the Board of Directors. This is the financial results. I would like now to turn the time over to S.Y. Hsu.
Ladies and gentlemen, good afternoon. I am S.Y. Hsu. I would like to explain our business objectives. We have 3 main key business objectives. The first is to manage market dynamics. The second is to expand in addressable markets, and third is to focus on areas of growth. In the markets. Nick Wu mentioned that the trade war between U.S. and China and Japan and Korea have created a lot of uncertainty in the market and impacted consumer confidence. In Europe we have a lot of competition in terms of pricing. And in the second half of this year, component costs may rise. However, at ASUSTeK, we will continue to improve product innovation, quality and improve precision and efficiency in our operations. In operations, we have relieved the situation with Intel CPU shortage and made certain adjustments. Currently, we are entering a new product cycle in terms of gaming phones and gaming PCs. The preorder amount is higher than expected. In operations, we will focus on areas of growth and seek growing segments and segments of [ differentiation ]. So in terms of gaming notebooks and thin and light notebooks, we will focus on the creator market which we have worked on since 2011. So for monitors, desktops, notebooks, peripherals, we hope to create a complete creator product line to improve innovation, quality; meet the needs of consumers; and create our competitive edge. In market strategy, we seek to produce product value and differentiation to capture different markets and region by creating teams to focus on special and corporate users. Since December of last year, when we announced our major phone transformation strategy -- I'm sure many people have been watching to see if our strategy succeeds, and they are still watching. This year, we have launched ZenFone 6 and ROG Phone II. On July 23, we launched ROG Phone II with Tencent in China, and it was very well received in the market. The amount of preorder has also exceeded expectations. In the first 24 hours, preorders exceeded 2 million units, and this must break some kind of record. The first batch of 10,000 units was sold out in approximately 70 seconds. Of course, our partner Tencent have also been very committed. They have optimized software and created added value in games, which has expanded the gaming segment. Our strategic partners have also recognized our efforts in the game market and look forward to the expansion of the game market. In the next 3 years, we seek to become the unmatched market leader. The ROG Phone II is a product of cooperation between ASUS and Tencent. This is a first time for Tencent because this marks the first time that any game software has been optimized for a specific product. So the product, ROG II, features a 120-hertz display; a high refresh rate; air trigger; as well as special features such as special vehicles for racing games as well as other features in other games. Also Tencent has publicized the ROG Phone through the game King of Glory. We believe that the integration between software and hardware is of great help to the development of the gaming market and ecosystem. We will continue to work closely with industry leaders to promote and expand the game phone market. I would like to turn it now over to Samson.
Ladies and gentlemen, good afternoon. I am Samson Hu. I would like to report on market and product strategy. In terms of the market, I am proud to share with all of you that ASUS in Southeast Asia is #1 in motherboards, notebooks and gaming notebooks in this first half of 2019. For example, in Southeast Asia the -- we account for over 30% of the notebook market and over 40% of the gaming notebook market. In Indonesia our notebook market share is 40% and our gaming notebook accounts for 55%, and we have been #1 in Indonesia for a long time. In Thailand, in June, we reached 30% market share in notebooks and 46% market share in gaming notebooks. This is the first time that we have reached #1 in Thailand. So ASUSTeK will focus on Southeast Asia as a major market. And we hope to create a strong leadership position, much as we have here in Taiwan, in our home market. In thin and light notebook growth, our in-house share has grown from 40% to 57%. Our unit growth year-over-year has reached 40%, which greatly exceeds the market average of 27%. This shows that our focus on thin and light notebooks is reaping rewards. We are also dedicated to innovations such as ScreenPad, minimum bezels and other product features. In terms of gaming notebook, millennials continue to make up the foundation of the gaming industry, and we expect that growth in gaming notebooks will continue its double-digit trend. So in the first half of 2019, gaming notebook shipments continued to grow and grows at a faster rate than the industry average. Outside of China, the ROG growth is 13.3% year-over-year, which is 5% greater than industry average. Around the world, ASUS gaming notebooks is #1 in 15 countries, and we will continue to work on product innovation to maintain our leadership position. In new product categories. In addition to our consumer and gamer market, we will continue to expand and include new segments, including creator and professional products or commercial products. We will continue to create market value through innovation by expanding screen size on products such as ScreenPad and thin bezel in order to create the best user experience. We hope that, in the second half of 2019 to 2020, our notebook growth, year-over-year growth, can remain steady and even inch into positive growth. In our gaming product line, we hope to create a very comprehensive product line, including motherboards, PC, ROG Phone, peripherals; and connect with our team in China to create alliances with content companies and communities around the world and create our unique advantage in ROG products. I mentioned creator products before. This is a new market for us which we have started in 2011. We hope to round out this product line. Next, I would like to preview for all of you that we will make an announcement, at the upcoming [ EVA ], to the media and to the public our vision and our deployment in terms of creator market. In the commercial or professional market, we will establish a special team in order to develop creator and corporate products. That is my brief presentation. Thank you.
[Operator Instructions] Our first question is from [ Mega International ]. "I would like to ask about the dividend of at least TWD 10 per year. Is this based on a dividend payout ratio?"
I'd like to answer this. In the next 3 years, we will have a cash dividend of at least TWD 10 per year. This is what we hope to be an absolute amount. This provides a stable and clear basis of reference.
Our second question is from Morgan Stanley. Can you explain your views on U.S. tariff and whether ASUS has built up inventory in the U.S. to minimize the impact of the tariff?
I'd like to expound on this. Regarding the U.S.-China trade war, we believe that this is a long-term issue that we have to face, that this will not be resolved in the short term. So I believe ASUS and the entire industry must face this challenge. In terms of inventory, we anticipated that there would be an escalation in the trade war, so we have built up 2 to 3 months of inventory. The tariffs will start on September 1, so I feel that, in the first 2 to 3 months, we can cover the inventory. Afterwards, we have also been making preparations. We've been discussing with our ODM partners to transfer our production base. The new production will, hopefully, connect with our inventory. However, transferring our production base will create higher costs compared to production in China. So the entire industry, including our ODM partners and our brand, we will have to make suitable adjustments. And in terms of our sales channels, we will also make appropriate adjustments at the right time.
The next question is from JPMorgan. In addition to the cooperation with the gaming phone, is -- your partnership with Tencent, does it include a financial aid? Or is there guaranteed minimum sales? Based on the competitive pricing strategy, is there a certain shipment that you have to hit in order to break even? And when do you expect to break even?
When we discussed our cooperation with Tencent, obviously we both committed resources. However, which resources and how much, these are details that I cannot go into. At our product launch, we can see that Tencent has provided support in software and in marketing, and these all have a corresponding value. Any committed resources have a corresponding value. So it may not be actual financial resources, but they have definitely boosted sales in our gaming phones. I'd like to make a comparison. I mentioned earlier that Tencent made a product placement marketing for our ROG Phone II in the game King of Glory. So in comparison with our ROG I, which is our first-generation gaming phone, it's also probably the first gaming phone worldwide, the ROG Phone had a preorder of less than 20,000 in the first 24 hours, but in -- for the ROG Phone II we have a preorder of more than 2 million in the first 24 hours. So that is a huge difference in terms of the resources committed into helping the sales.
It was also asked that, in terms of pricing, when can we break even. In China there is a Tencent version which is priced lower, but if you look carefully, it has different specs. I believe that, in order to be priced more competitively, we have some give and take. And we've made some adjustments in terms of specs that are not as important to our customers. Currently, in terms of the gaming market, it is still early, so right now, our goal is to expand the gaming phone market. So breaking even is not our first priority for the ROG Phone II. Obviously, internally we want to seek a financial balance. However, our main objective is to become the undisputed leader in the gaming phone market in 3 years and to open up the gaming phone market.
The next question is also from JPMorgan, about smartphones. It was rumored that there were some supply delay for the ZenFone 6. What is the situation now? And how can you avoid similar situations with the ROG Phone II? There is a preorder of 2 million for ROG Phone II. Can you fulfill all these orders in Q3?
Undoubtedly, we have some production issues with the ZenFone 6; and that is because we used a unique material, liquid metal. We used liquid metal because we needed to create this durability in our product. We have this flip camera. Because it is flippable, because it moves, and therefore we need to ensure that it is strong enough and durable enough. Some people online have performed crazy stunts with our products using our ZenFone 6 to open bottles or to lift a 20-kilogram weight, but I'm sure most people know that they shouldn't use their phone like this. This is also a main issue for our design team because we have this flip camera, which is a huge feature of our ZenFone 6, so we need to exceed consumer expectations. Therefore, the -- our early supply was not great. However, we have resolved that situation. Speaking of ROG Phone II: It has been extremely well received by the market, exceeding our expectations. I said earlier that preorders exceeded 2 million. However, in China we cannot really say preorder. It's more like a reservation because they reserve the phones. They haven't paid for them yet. Therefore, there is a conversion ratio about how many phones will actually be bought. We hear that 3% to 5% of reserved products are actually paid for, but with the ROG Phone II we believe that this will exceed the average, and we expect 10% shipment. So in Q3, if we need to fulfill all 2 million reservations, I believe that we do not need to reach that number. We will do our best to fulfill all orders. It may be a bit tight, but we believe that we will do it.
Third question from JPMorgan. ASUS has focused more on commercial notebooks and Chromebooks. When do you expect to see significant revenue?
I believe that there are 2 factors. The first is product readiness, and the second is the new sales channels. In terms of product readiness, our commercial notebooks and Chromebooks will probably be available in Q4 or Q1 of 2020. As for sales channels, this requires a bit more time because each region has different requirements in terms of sales channels. So we believe our objective is Q1 of 2020. Therefore, we expect to see revenue or profit for commercial notebooks in the second half of 2020.
The fourth question from JPMorgan. Excluding phones, the operating margin for Q2 is 3.1%. In the second half of this year, is it possible to reach over 4%?
I'd like to report that ASUS has made improvements in product innovation, quality and sales channels. However, we need to face many industry variables. In Q2 to Q3, the U.S. trade war continues and may even exacerbate. So in the short term, PC component costs may rise moderately. So in Q3 or the second half of this year, excluding phones, our operating margin aims to achieve 3% or perhaps higher.
Our next question comes from UBS. Can you explain a bit more about creator PCs? In terms of this category, what kind of products will you produce?
I mentioned earlier that we will have a more complete announcement at [ EVA ]. We will share with everyone our product line, including our original display monitors. And we will also announce our desktop and notebooks.
Our next question comes from DIGITIMES. ROG Phone II is a cooperative partnership with Tencent, but Tencent has also partnered with Qualcomm. Does this affect the ASUS relationship with Qualcomm?
I'd like to explain that, when we first discussed the second generation of the ROG Phone, we had a 3-way discussion between us, Tencent and Qualcomm. Obviously, ASUS and Tencent committed resources into the ROG Phone II, whereas Qualcomm made -- supported more in terms of the ecosystem. Tencent and Qualcomm have a partnership in 5G development. This is because the fastest 5G market is still in China, and due to the U.S.-China trade war, China views 5G development as a display of national strength. As far as I know, in China, in Beijing, Shanghai, Guangzhou and Shenzhen, they expect to launch 5G signal in the subway systems of these 4 cities by Q4 of this year. This is a kind of political statement by China showing their strength in 5G technology. Of course, 5G is an important aspect of any phone development. Qualcomm, their chip is ready for mass production and they want a market in which to develop, whereas Tencent plays the role of a software developer and a platform, so the cooperation between Tencent and Qualcomm is great for 5G technology and it's very understandable and reasonable. Of course, in gaming phones, the product performance is key. Qualcomm plays an important role in the market segment of gaming phones. I believe this is why Tencent and Qualcomm entered into their partnership. And we also have some partnerships with Qualcomm in terms of 5G, and we're discussing future phone developments. When there are more developments, we will share them with you.
The next question comes from Yuanta Securities. In the second half of this year, will the rising costs of components affect the company? Also, the tariffs between U.S. and China, how will they affect the 3 market segments, including PCs components, PC ODM and PC brands? How will it affect these 3 segments?
In the second half of the year, in terms of components. I'm sure everyone is aware of the trade war between U.S. and China as well as Japan and Korea. In Japan and Korea, the restriction of production materials in semiconductors and displays, this may affect display or memory producers. And we understand from our partners that the impact is limited. If there is an impact, we believe that it is more of a man-made or artificial impact meant to take advantage of the situation, whether it's display or semiconductor producers, to hike up prices. So this is what we have observed. We have discussed with our suppliers how to minimize the impact of rising prices. So we hope that this will have a limited effect on our gross margin mostly because we already built up inventory. And second, as I explained, this will not seriously affect our suppliers. It will not seriously affect our supply side. As for how the U.S.-China trade war will affect these 3 segments: Companies that are more upstream will be impacted the hardest, so our brands and our ODMs who have to transfer their production base will obviously have a greater impact. So we need to be very cautious and find a suitable time to reflect these costs on our sales channels and our customers.
The next question is from [ Commercial Times ]. The ROG Phone II is mostly focused on the China market. When will it be launched in U.S., Europe or India? As for the U.S. tariff, is there a corresponding strategy?
We first launched ROG Phone II in China, first of all, because of our partnership with Tencent. Tencent has optimized software for the ROG Phone II. We plan to launch the ROG Phone II in other markets, and we will make announcements at [ EVA ] about the launch times for markets outside of China.
The next question comes from KGI. ASUS is very clear that you will focus on the growth of thin and light notebooks and gaming notebooks. What percentage will these products play in the shipments and revenue? Also, with thin and light notebooks and gaming notebooks, what are the factors in its gross or operating margin?
In terms of in-house share, thin and light notebooks account for 57% the first half of this year. Gaming notebooks account for 15% to 20%. As for revenue, it is similar. Thin and light notebooks account for probably double digits in revenue. As for the factors that affect gross margin and operating margin, there are a few different aspects: obviously, the cost of components; and the second, the things that we are in control of such as the product mix. We will continue to optimize our product mix in order to raise gross margin. Also product innovation can increase prices, which will also improve gross margin.
The next question comes from UBS. Can you please explain: In the U.S. market, is the inventory marked down as inventory or as sales in terms of accounting books?
There are a few issues to think about. In the sales channel, if it is shipped out to our sales channels, then it will be accounted as revenue or shipment. If it is on the way or if it is in hub inventory in the U.S., for us this is recognized as inventory. Only when it is in the sales channel will we recognize it as revenue.
We have answered all of the questions. We will wait to see if there are any more questions. [Operator Instructions] Our next question is from DIGITIMES. The DIY PC market continues to decline. The shipment of motherboards in 2019 versus 2018, what are the differences?
I would like to explain a bit. The DIY PC market around the world is in decline, and motherboard shipments have declined steadily in the past few years. And this has to do with differences and changes in PC usage. So in the short term, I believe that it is difficult to turn that around, so at ASUS what we can do is to continue to launch better and more attractive products to increase our market share so, even if the market is in decline, ASUS can still increase its market share. As for motherboards, we have created product differentiations such as our gaming motherboards and our commercial-use motherboards. So we seek to increase our ASP through product differentiation. This is our strategy towards the market.
Our next question is from Morningstar. The operating expenses have increased significantly in Q2. Why? And will this situation be resolved in the future?
In Q2, our objective for shipments and revenue has a higher base. However, because of the U.S.-China trade war and changes in the market, so in the end, our revenue is lower than expected. So our planned expenses in marketing or product development have remained relatively stable from Q1 to Q2. There is no great difference in terms of dollar amount. The change in operating expenses ratio is mainly due to the change in denominator. Looking to the future, in terms of our product line, we have set reasonable targets for our cost management. Generally speaking, in the long term, we hope to maintain our operating expenses ratio under 10%. This is achievable.
Thank you. We have generally made our report for today and answered the questions. Thank you for participating in today's investor conference. Thank you for your participation. If you have further questions, please contact us. Thank you all for your support and your guidance. We will continue to work tirelessly in the future. Thank you. [Statements in English on this transcript were spoken by an interpreter present on the live call..]