AUOTY - AUO Corporation (AUOTY) CEO Paul Peng on Q2 2022 Results - Earnings Call Transcript
AUO Corporation (AUOTY)
Q2 2022 Results Conference Call
July 28, 2022 02:00 AM ET
Company Participants
Julia Chao - Investor Relations
Paul Peng - Chairman & Chief Executive Officer
Frank Ko - President & Chief Operating Officer
Benjamin Tseng - Chief Financial Officer
James Chen - Senior Vice President of Display Strategy Business Group
Conference Call Participants
Jerry Su - Credit Suisse
Derrick Yang - Morgan Stanley
Lisa Chen - Yuanta Securities
Presentation
Operator
Welcome to AU Optronics 2022 Second Quarter Results Conference Call. Before the meeting commences, all lines are placed on mute. After the presentations by the management team, there will be a question-and-answer session.
Now let's welcome. Ms. Julia Chao, AUO’s IR officer. Thank you.
Julia Chao
Ladies and gentlemen, good afternoon. I'm Julia Chao AUO's IR officer. On behalf of the company, I would like to welcome you to participate in our second quarter financial results conference. I'm joined by four executives, Paul Peng, Chairman and CEO; Frank Ko, President and CEO; James Chen, Senior VP of the Display Strategy Business and Ben Tseng, CFO.
The agenda is as follows. First of all, CFO, Ben will go over our second quarter results and provide you with our guidance for Q3. Our Chairman, Paul will then have an opening remark. Afterwards, we will have our question-and-answer session. We have collected questions for analysts before the meeting, and we will address these questions in the first part of the Q&A session. Afterwards, if you still have more questions, we will open the line for you to call. So that was our agenda.
Now, before I turn over to Ben, please allow me to remind you that all forward-looking statements, contain risks and uncertainties. Please spend some time to read the Safe Harbor notice on Slide 2. Ben, please.
Benjamin Tseng
Good afternoon. I would like to firstly go over our 2022 second quarter results. Due to suppressed consumer demand, amidst rising inflationary pressure and lockdown measures in China as well as increased inventory levels of customers on the back of easing port congestion, customers have become much less aggressive in their panel purchasing activities.
Our area shipment and ASP both went down by more than 10% Q-o-Q. Net sales came in at TWD62.9 billion down by 23% Q-o-Q. Gross profit was TWD1.7 billion, OP loss TWD4.6 billion. In Q2 where we recognized TWD1.93 billion in taxes on distributed earnings, as a result, net loss attributable to owners of company was TWD5.6 billion. We estimate that, we would have sufficient investment in Taiwan for tax credit of investment. Therefore, we won't have net cash offer in that regard. EBITDA margin was lowered to 5.2%.
Next Slide, balance sheet. At the end of Q2 cash was TWD84.9 billion, down by TWD5.2 billion Q-o-Q. Long-term and short-term debt combined was TWD52.8 billion. Net debt to equity ratio was negative 14%. In response to rapid contraction of customer demand, we lowered our UT rates quickly while persistently controlling the inventory levels prudently. Our inventory amount was TWD37.2 billion, flattish from a quarter ago. However, on the back of the much lower inventory level, inventory turnover days increased to 56 days.
Cash flow we generated from operating activities, TWD9.3 billion in Q2. CapEx was about TWD8.1 billion, equity investment. TWD1.3 billion, outflow for financing activities was TWD6.1 billion, mainly due to debt repayment.
Next slide, revenue breakdown. During the quarter, the segment that saw a bigger change in its share as mobile, PC and device with the share going from 33% to 24%, reflecting customers weaker purchasing momentum amid higher inventory levels. Moreover, automotive solutions share increased from 9% to 14% benefiting from the alleviation of IC shortages.
Revenue breakdown by size. 10 to 20 inch segments share decreased from 47% to 42%. Again, due to contraction of notebook demand. 20 to 39 inch segment share increased from 24% to 28% due to decreased monitor revenue contribution and the increased revenue contribution from ultra large size car displays. 10 inch and below segment, share increased to 10% due to increased contribution from smaller car displays.
Shipments and ASP by area. Shipment area decreased by about 19% Q-o-Q. Meanwhile, ASP decreased by nearly 14% Q-o-Q. Now for our Q3 guidance. Based on our current business outlook, we expect that area shipments to be down by mid-teens percentage points Q-o-Q. Blended ASP denominated in the dollar is projected to be roughly flat Q-o-Q on an improved product mix. Loading rates for the third quarter will be dynamically adjusted based on market conditions. So this is our recap of our Q2 results and guidance for Q3.
Before we proceed with questions and answers, we will have Paul to provide an opening remark.
Paul Peng
Ladies and gentlemen, good afternoon. In Q2, the market abounded unfavorable macro conditions, the rising inflationary pressure also aid into consumer consumption power, suppressing end market demand significantly. Currently, inventory levels at channels increased substantially and brand’s focus on digesting their existing inventory level causing them to reduce their panel purchasing activities.
In the second quarter, due to lockdown measures in East China, our fabs in Kunshan and Suzhou saw their production and shipments impacted significantly. Although, the situation has been improving since May, and we have been working very hard to minimize the impact; however, customer demand weakened causing us unable to reach our shipment goals as we projected in Q2. Panel ASP was also affected by a weaker market demand. And the drop in ASPs was far bigger than our projection. Although in Q2 NTD’s depreciation was favorable to us.
Our revenue still went down by 23% to 62.9 billion. We have also turned into the red. However, at AUO, we have placed a very high importance to inventory controls. As customers demand shifts, we place more focus on adjusting our inventory. So we will keep our inventory levels at a tight control, but as customers stream their orders very quickly, we still try to catch up with the pace of their inventory adjustments moves.
Inventory turnover days has increased and shipments dropped significantly. Going forward, we will keep a tighter control of our inventory levels, so as to provide a better support of our cash flow. Currently, our gearing ratio was negative 14%, which is a very healthy level.
As for Q3, Russia and Ukraine world is still ongoing and may not end soon. And inflationary pressure will still be with us for some time in June. In Europe and U.S. CPI increase by 8% to 9% Y-o-Y, 18 --and historic high or 40 year new high. This has caused food prices, energy prices to surge. So consumers’ disposable income have been pinched significantly causing the demand for IT and TV products to weaken significantly.
Moreover, central banks around the world raised to increase interest rates to fight against inflation, which will be unfavorable to the world's economic growth. Usually in Q3, it is the time for brands to restock ahead of the year-end holiday season. However, given the uncertain economic outlook at the moment and the fact that inventory levels have been higher than normal due to poor congestion and market demand has lowered.
Currently branded customers have lowered their orders and are focusing on adjusting their inventory levels. Our view is that, inventory levels at channels may still take some time to readjust. And in China, panel makers see their channel inventory levels higher than normal due to non-economic factors. This means that, inventory digestion from channel to panel makers may still need to take some time. As a result, we will maintain a more conservative view about this market demand going forward. However, we will continue to pay close attention to market developments across the board.
Due to the macro conditions, demand has split; however, there's a good news -- good piece of news that is car sales have finally shook off the shadows. Last year. This sector was hit hard by shortage of labor and shortage of components. And in the second half, the problems or the issues have been easing. Moreover, on the back of the rising trend for electric vehicles and self-driving cars, we are positive about the outlook for car display markets over the longer-term. Therefore AUO will increase our investments in the car display applications.
Yesterday, our Board of Directors has decided to increase our capital investment in car display applications. We believe that, car displays will be one of the important growth drivers of AUO for the next few years. The downturn this time came hard and fast. Previously, the panel industry suffered from such downturns due to over centralized station of supplies and the market conditions usually improved after some rebalancing.
However, this year, the downturn was caused by the macro conditions, such as energy shortage and the ongoing war. A lot of factors are not associated with the industry itself. So this makes it especially difficult to keep those factors under control. AUO has been through many ups and downs in the past. While we cannot control external conditions, we can keep a tight control of our internal operations to minimize the negative impact.
We will do our best to fulfill several goals. First of all, we will have a tighter control of our inventory management. In Q2 inventory days increased, however, due to our tight control of inventory levels, inventory amount still lowered. In the future, we will continue to keep our inventories and our UT rates under control. Secondly, we will control our cash flow prudently in light of the demand contraction at the moment
For this year, our CapEx will be lowered by 20% from our earlier expectation from TWD45 billion to TWD36 billion. Moreover, we will continue to pursue biaxial transformation. The goal is to make AUO more resilient to the [boom member] cycle of the panel industry. We will work on several aspects.
Firstly, we will continue to develop next-generation LED technologies, and we will also build complete ecosystem. Our micro LED associate, PlayNitride, will be listed on the public market in Q3. Through that we will continue to invest in many LED and micro LED development. Furthermore, we will invest more in developing smart applications. Our subsidiary, AUO Display Plus, recently purchased a U.S. based smart education software company. In alignment with biaxial transformation strategy, we will increase our investment and resource allocation in smart applications and smart fields.
In terms of macroeconomic conditions, there are many more black swans and gray rhinos this year. The macro environment has been far worse than expected. Because of these factors, the global economy and the entire panel industry are facing stiff headwinds. AU has been [enjoyed] at navigating through industry headwinds. We have been well prepared to handle challenges and we are capable of managing cash flow well. We will do our best to maintain financial health and to maintain steady growth despite the market downturn.
With our defined strategy in place, we will continue to pursue biaxial transformation. We aim to redefine AU so that we will no longer be just a pure display supplier. We hope that our non-pure display revenue will continue to increase so that we will be able to minimize the impact on our operations of industry cyclicity.
Thank you.
Question-and-Answer Session
A - Julia Chao
Thank you, Paul. Now we will start with our question session. For the first part of the Q&A we will address the questions that we have collected from analysts. The first group of questions are relating market updates and outlook.
First up, given the production reduction plans by panel makers, what is your view about supply and demand of the panels in the second half? The second question is about TV sale force in various regions, and our view about the demand in the third quarter? Frank, would you please address these two questions?
Frank Ko
Good afternoon. I'm Frank. First up, about market demand and supply. In terms of the supply side, during Q2 and Q3 panel makers initiated production reduction plans and started to adjust their product mix. Moreover COVID related lockdown measures in East China in Q2 rattled the industry supply chain with lingering impact so far, therefore effective capacity of the industry has lowered.
As for the demand side due to the Russia-Ukraine war and rising inflation pressure consumers have become more conservative in the post pandemic era as demand weakened due to rising travel demand and other factors. Commodity consumer products took a hit; however, non-commodity products were less affected.
Car displays and high-end medical applications are enjoying relatively stable demand. Car displays, especially have seen improvements from the supply side. Market conditions will likely improve in the second half. In the second half, which will be a traditionally strong season for promotional activities in China, especially after the lockdown measures were lifted, the market has been recovering on the June 18th shopping festivals online sales. TV sale grew by 11% Y-o-Y, 65 inch and above products share has also increased to nearly 50%.
As for Europe and the U.S. demand has been weakened since the second quarter. However, ultra-large size TVs models continue to enjoy strong demand, 85 inch sale-through increased by 40% Y-o-Y. As for emerging markets, the market has been recovering nicely. TV sell-through growth was in the double digital range in the second quarter.
In India, TV sale-through growth was more than a 100% in May. Over the longer horizon, the demand will continue to ride on the impact of the global economic conditions. We will have to observe the impact of holiday season to have a better understanding of demand for TVs.
Julia Chao
Thank you, Frank. Could you please talk more about IT products, and also inventory levels?
Frank Ko
The IT market has taken a sharp turn since lockdown measures implementation in East China since Q1 and also the start of the Russia-Ukraine war. However, since the beginning of the pandemic, IT has benefited from remote learning and remote working demand.
Today, demand has become weaker and as transportation and poor congestion situation improved, in-transit inventory or inventories previously were jammed up at ports, have gradually arrived at channels causing channel inventory levels to rise significantly. Currently, brands focused on digesting their excess inventories and have launch promotions ahead of time, especially for back-to-school and Prime Day promotions. The impact on inventory digestion will be a point worthy of observation.
For financial related questions, in Q2, we have lowered our UT rates to 70% in light of lower demand. For Q3, we will adjust our UT rates dynamically based on market conditions. For depreciation and amortization, the amount was TWD7.9 billion in Q2 and TWD15.9 billion in the first half. For 2022, we expect the amount to be TWD32 billion. CapEx in Q2 was TWD8 billion and TWD16.4 billion in the first half. We will slow down ramp up for the remainder of the year with the expectation of our CapEx to lower to TWD36 billion for 2022.
Next, about the currencies impact on our margins in Q2. In the second quarter, NTD weakened by 4.7% against the dollar and strengthened by 5.4% against the Japanese yen. These two factors combined had a positive impact of 0.8 percentage points.
Julia Chao
So, these were financial related question. The next group of question are about AUO's key products and technologies. As end market demand weakened, car display performance has been different. What is yours view? So James, please answer this question.
James Chen
Ladies and gentlemen, good afternoon. I'm James. As Paul have, and Frank said, the consumer products have been impacted by rising inventory levels, we have become more conservative about market outlook. However, in terms of product, technology and developments, we have been working very closely with our customers. We are developing new features for our products in hopes of meeting higher expectations. When market demand resumes, we will stand at a better advantage. So, we are maintaining our collaboration with customers in the development of new features and new technologies for consumer applications
Meanwhile, our car displays performed relatively better in Q2. We saw growth in terms of the shipments and revenue from car displays. Mainly benefiting from an improvement in car display related supply chain, moreover amid the rising electric vehicle and self-driving trends. Car displays not only see screen sizes increasing, but also usage scenarios increasing. Currently, demand visibility is pretty good. We are also seeing growth in new orders and projects.
Therefore, AUO will increase our investment in car display technologies. We will invest more in building up our technologies and capacity. We will leverage our LTPS production capacity and integrate our form -- free-form cutting, lamination and touch integration capabilities as well as pursue closer collaboration with car makers to provide system integration services, to enable car makers to differentiate designs. We believe that starting from next year and into 2024, car display will have a bigger contribution to our revenue.
Operator
[Operator Instructions] The first call is Jerry Su from Credit Suisse.
Jerry Su
I have several questions. First of all, with your duty rate lower into 70%, what was the impact of LCM and idle cost on your gross margin in Q2? And also, your view about the prospects in Q3. Secondly, about CapEx, you announced that you will build a GEN 6 engine 8.5 fab in Taichung? In light of the current market conditions, are you making any adjustments to the plan, especially when Chinese panel makers are ramping up their GEN 8.8 and 8.5 and 8.6 fabs against this backdrop. Do you have any ideas to your ramp up progress?
The last question is about cost reduction. Could you provide more color? How are you working on reducing your cost outlook?
Benjamin Tseng
Jerry, Hi, I'm Ben. About LCM or idle capacity cost indeed at lower ASPs or lower utilization rates, these items of expenses do appear. And in Q2, we have recognized these expenses in our financial results. In Q3, depending on market conditions, we will assess the entire picture. If we decide that producing a particular product would turn in profits or cash flows, then we will decide to manufacture this product. The adjustments of our UT rates will depend on whether the product will be able to generate positive cash flow.
For your third question on cost reduction, this is a direction that we have been pursuing since Q1 this year. We have seen that material costs have stopped rising and instead they have been trending downward. In Q2, we continue with our cost reduction plans. We now expect that we will have 2% to 3% reduction in our cost in Q3.
Paul Peng
Hi Jerry, I’m Paul. Additional points for the CapEx. This year we have decided to lower CapEx by 20%, part of which is associated with the delay of the construction of the new plant in Houli. We haven't programmed in Houli plant. The construction has been put on hold.
Jerry Su
So it is simply delayed, but not scaled down.
Paul Peng
Correct, we are delaying the construction and will break ground and start construction depending on market conditions.
Jerry Su
Also, about the impact on your gross margin from LCM and idel capacity in Q2.
Benjamin Tseng
Hi, this is Ben. LCM was about NTD700 million. Idle cost around NTD1 billion more or less. Again, whether to produce a product we will examine the probability of turning in positive cash inflow.
Operator
The next caller Derrick Yang from Morgan Stanley. Please go ahead.
Derrick Yang
Good afternoon, executives. For your Q3 ASP guidance, you mentioned earlier that blended ASP is expected to be flat Q-o-Q. Given the area difference between TV and IT products, how much of the guidance was due to the impact of your product mix? Or could you talk about your TV and IT ASP trend projections for Q3?
Benjamin Tseng
Hi. I'm Ben. Indeed, the ASP guidance is partly a reflection of the adjustments of various product lines. We normally arrived at the optimal product mix based on the contribution of our cash flow of each product line. So, we shouldn't just single out TV or IT products here.
Derrick Yang
Thank you. May I have a follow-up. Since your mobile product was severely affected by the lockdown measures in East China in Q2, can we assume that the performance of your mobile products will be back to normal in Q3? Is that a correct assumption? How this has changed?
Benjamin Tseng
In Q2, our IT products were mainly affected by customers' inventory adjustments and lockdown measures in East China. In Q3, lockdowns have already been lifted; however, customers continue to adjust their inventory levels. Currently, we hope that with back-to-school and Amazon Prime Day promotional activities, customers will be able to digest their accessories nicely. However, there are still uncertainties.
Operator
Ladies and gentlemen, in the interest of time, we will take one last question. We'll take questions from one last caller. The last color is Lisa Chen from Yuanta Securities. Please go ahead.
Lisa Chen
Good afternoon executives. Thank you for the detailed information. My first question is about your non-GAAP items. What are the major non-GAAP items? Do you have any number data points for your SG&A and R&D expenses? Secondly, given the huge impact of the lockdown measures and poor congestion, did your expense suffer? Do you expect the impact to alleviate in Q3? Thirdly, could you provide more details on the income tax number?
Benjamin Tseng
Hi, Lisa. I'm Ben. Of the non-GAAP items, the major items included, much bigger drop in interest expense, because in the past, we had higher interest expense, given that we had more debt than cash. After making adjustments over the past few quarters, today we have more cash than debt causing a visible drop in the interest expense.
Moreover in Q2, we received a subsidy of NTD400 million plus.
As for SG&A and R&D expenses, the change wasn't that significant, however, in terms of sales, because transportation cost remains to be high so the impact on our cost remains to be relatively higher. As for tax, as we mentioned, we recognized 1.93 billion for undistributed earnings tax. According to the accounting rule, after the stock dividend decision by the Board of Directors, any surplus will be subject to undistributed earnings tax of 5%, which was recognized in the Q2 results. As said, we will be able to receive investment tax credit through our investments in Taiwan. So as to avoid income tax related cash outflow.
Lisa Chen
What about the impact on your cost from poor congestion and the lockdown measures in Q2?
Benjamin Tseng
Yeah, there was some impact, definitely. COVID related anti COVID measures will be reflected in our expenses. So there will be some alleviation in Q3. We hope that the similar circumstances won't happen again.
Julia Chao
Thank you for your participation in the quarter's results conference. This concludes our results conference call today. If you have more questions or requests, please feel free to contact us at AU’s IR Department.
Operator
Thank you for participating in the second quarter 2022 investor conference of AU Optronics. You may all disconnect now. Thank you.
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AUO Corporation (AUOTY) CEO Paul Peng on Q2 2022 Results - Earnings Call Transcript