U.S. Markets open in 7 hrs 16 mins

Edited Transcript of 066570.KS earnings conference call or presentation 28-Apr-17 12:00am GMT

Thomson Reuters StreetEvents

Q1 2017 LG Electronics Inc Earnings Call

Seoul May 2, 2017 (Thomson StreetEvents) -- Edited Transcript of LG Electronics Inc earnings conference call or presentation Friday, April 28, 2017 at 12:00:00am GMT

TEXT version of Transcript

================================================================================

Corporate Participants

================================================================================

* Do-Hyun Jung

LG Electronics Inc. - President, Chief Finance Officer and Representative Director

================================================================================

Conference Call Participants

================================================================================

* Mark C. Newman

Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst

* Nicolas Gaudois

UBS Investment Bank, Research Division - MD, Head of APAC Technology Research and APAC Technology Strategist

* Richard Alan Kramer

Arete Research Services LLP - Senior Analyst

================================================================================

Presentation

--------------------------------------------------------------------------------

Unidentified Company Representative, [1]

--------------------------------------------------------------------------------

Good day, everyone. Welcome to LG Electronics' Q1 2017 Conference Call. This is [SC Kim] and our IR members are here with me today.

Now let me start with our earnings. As always, please note that all information regarding our performance and financial results were prepared in advance and have not been reviewed by outside auditors yet, therefore are subject to change in the process of final review. All forward-looking statements may be different from those expressed or implied by the changes.

Now I'd like to start with our Q1 results. First, let us give you a brief overview of our income statement. Our consolidated revenue for the quarter was KRW 14.7 trillion, and operating profit was KRW 921.5 billion. Despite the seasonality and sluggish market environment in TV and Mobile business, Q1 revenue increased 9.7% Y-o-Y, mainly driven by the strong performance of H&A and record growth of PC division.

For the operating margin of total company's side, Q1 operating margin increased significantly, both Q-o-Q and Y-o-Y, thanks to the continued premium sales increase in H&A and HE division. For HE division, the result of significant improvement activity, which has started from second half of last year, has begun to become visible, and revenue count for Q1 was KRW 835.7 billion.

As for our credit statement of financial provision and cash flow statement which we will report on our presentation this year was posted on our global website.

Now, let us give you a brief overview of Q1 performance and Q2 outlook by each division. First, let me just start with our Home Appliance Air Solution division, HA&A. The revenue increase of 10% Y-o-Y, 15% Q-o-Q, mostly driven by the stronger performance in domestic markets. For domestic market only, the revenue increased 33% Y-o-Y, thanks to the premium product sales of the TWINWash, bottom freezer refrigerator, air-conditioner and newest model of Styler air purifier and dryer. Despite the raw material price increase, product stability improved substantially, driven by growth of premium product sales and product mix improvement.

In Q2, as we entered the peak season, solid profitability could be achievable by expanding several premium products and efficient expense operations.

Turning to Mobile Communications division. Total shipments for the smartphone in Q1 was 14.8 million units, with the strong sales of our new 2017 lineup of K Series and X series, and successful launch of PC in domestic markets. So revenue increased 4% Q-o-Q.

On the operating margin side, the impact of last year's business structure improvement activity and successful launch of the new model in Q1 as the reason for flexibility to improve substantially on our Q-o-Q basis.

In Q2, we will continue to put our best effort to retake our premium position by the global launch of G6 and enhanced profit improvement momentum in order to secure meaningful, profitable growth.

Moving to Home Entertainment division, HE. Revenue decreased Q-o-Q due to the seasonality and weak demand in Middle East, Africa and Asia region. However, in Q1, margin improved Q-o-Q by premium products further expansion and cost structuring improvement, also, along with flexible operations to cover the final price increase.

In Q2, HE division is expected to secure solid profitability by increasing the revenue of the premium TV, such as OLED and the UHD TV.

Finally, as for the VC division, revenue increased to 48% Y-o-Y, thanks to the growth in the infotainment business as well as electric powertrain components, mainly driven by the actual ramp up of the GM Bolt project. VC division saw modest operating loss of KRW 14.5 billion in the quarter, reflecting continuous R&D investment to support the future growth. However, by utilizing the synergies with LG affiliates, we will continue to enhance our internal capability to lead to the new content and the technology.

In order to strengthen the business, we build up solid strategic partnerships to obtain orders and enhanced customer satisfaction from design, quality and safety. Hence, in Q2 2017, for the total company side, excluding LG Innotek, we anticipate high single digit Q-o-Q revenue increase and stable operating margins.

Okay then that's all for our Q1 2017 results as well as our outlook for the Q2 this year. Thank you for listening. Now let's begin the Q&A session. Operator, we are now ready to open the Q&A session.

================================================================================

Questions and Answers

--------------------------------------------------------------------------------

Operator [1]

--------------------------------------------------------------------------------

(Operator Instructions) The first question will be provided by Richard Kramer from Arete Research.

--------------------------------------------------------------------------------

Richard Alan Kramer, Arete Research Services LLP - Senior Analyst [2]

--------------------------------------------------------------------------------

I have several questions. I guess the first one, could you -- could we talk for a bit more detail in the division? What we saw last year, in TVs, for example, was you had really record levels of margins, and then, it obviously dropped off in the end of the year, and some of that was because you were spending less on marketing. So can you tell us, are there any spending that you'll have to increase over the course of the year, for example, in marketing in TVs? Or is that new -- that's the high single -- very high-single-digit margin you've seen in 3 of the last 4 or 4 of the last 5 quarters sustainable? And then, I have several other questions.

--------------------------------------------------------------------------------

Unidentified Company Representative, [3]

--------------------------------------------------------------------------------

(inaudible)

--------------------------------------------------------------------------------

Unidentified Company Representative, [4]

--------------------------------------------------------------------------------

Thanks for waiting. So the reason why we had that much of the high profitability in the first quarter it was the kind of the increase is that their needs in the first quarter, of course, like we standing out like a premium product sales. Then second reason is that we improved our price competitiveness once we sell more of the premium products and our trend equity increased a lot in the market. So that's why we can have a stronger price competitiveness. On the second quarter, as you mentioned, of course, we plan to improve more the marketing expenses, because normally we launch the new model in the second quarter. However, given the very stable business structure, and then more the higher -- the premiums, the premium sales cushion, and then we think we can keep that rate base on high-single-digit margin until second quarter.

--------------------------------------------------------------------------------

Richard Alan Kramer, Arete Research Services LLP - Senior Analyst [5]

--------------------------------------------------------------------------------

Okay. On the Mobile business. You lost KRW 1.3 trillion last year, and now you had a breakeven and a very high level of shipment. How much of cost that you might have incurred this year were covered by that very large restructuring charges, especially in the second half of last year? And given the delays to the launch of your new flagship and your comments about intensified market share competition, is there any expectation that during 2017 that Mobile could be profitable at any point this year since at the end of last year, you seem to be saying it was very unlikely?

--------------------------------------------------------------------------------

Unidentified Company Representative, [6]

--------------------------------------------------------------------------------

(inaudible)

--------------------------------------------------------------------------------

Unidentified Company Representative, [7]

--------------------------------------------------------------------------------

For the question, for MC division, we, in this year, we think that, we believe that we can at least reduce more than KRW 1 trillion loss amount compared with the last year to this year. This is mainly because we did a lot of activities on the business restructuring, started from last year, July. So at least KRW 1 trillion loss amount can be reduced in this year. In the second quarter, probably the loss amount that's going to be -- it will be a little bit -- we are expecting to mark a little bit of more loss because in the second quarter due to the global launch of G6, probably there will be a marketing spend for the second quarter. However, in the second half of this year, we expect that there will be a certain quarter that's going to be a turnaround period. And for the full year, our guidance will be in the range of around KRW 100 billion to KRW 200 billion loss because we are going to -- we are expecting to reduce KRW 1 trillion loss amount compared with last year to this year.

--------------------------------------------------------------------------------

Richard Alan Kramer, Arete Research Services LLP - Senior Analyst [8]

--------------------------------------------------------------------------------

Okay. And then, my last question, clearly, the strange thing if you look on Page 3 was that the business actually didn't generate any cash, even though, you had, obviously, this record operating profit. Can you talk through in a little bit more detail, how much foreign exchange benefited the top line or had a positive impact on profitability or a negative impact? And why is it that you weren't able to translate that really record net in operating profit into cash flow?

--------------------------------------------------------------------------------

Unidentified Company Representative, [9]

--------------------------------------------------------------------------------

Actually the main reason, even though we have the higher operating profit, but the net cash flow is a little lower than your expectation is, the main effect is from the (inaudible) asset, if you move it from the cash still dominating the foreign currency. And then, there's some issues -- there's some changes in the overall transactions. So there's another main issues for this to happen.

--------------------------------------------------------------------------------

Richard Alan Kramer, Arete Research Services LLP - Senior Analyst [10]

--------------------------------------------------------------------------------

Do you have a sort of constant currency revenue growth number you might be able to share? Or was there a significant positive impact from foreign exchange on the operating profit?

--------------------------------------------------------------------------------

Unidentified Company Representative, [11]

--------------------------------------------------------------------------------

Although we have -- we're using so many different currencies, so we think over the like FX effects naturally having each others. But the full year, the reference, we are in the, like the dollar disclosures, we are now very the normal -- I mean, the general -- to the neutral, I'm sorry. Neutral to the dollar assets. But in the, like, division by division, we are still short for the TV, and the TV is a little short for the dollar, and then the other division has a loan position.

--------------------------------------------------------------------------------

Richard Alan Kramer, Arete Research Services LLP - Senior Analyst [12]

--------------------------------------------------------------------------------

Okay. And I guess the last question is, clearly the most profitable division by far is Home Appliance. You had a big increase in domestic market shipments, which I know was also very profitable. Is that sustainable through later quarters in the year? I know the second quarter typically is the peak season of the year.

--------------------------------------------------------------------------------

Unidentified Company Representative, [13]

--------------------------------------------------------------------------------

(inaudible)

--------------------------------------------------------------------------------

Unidentified Company Representative, [14]

--------------------------------------------------------------------------------

In the second quarter, we expect the sales is going to be sort of like high single digit of Y-o-Y, and especially domestic market is going to be strong. And in the second quarter and the full year 2017, we expect we can maintain high single digit of full year margin for the full year.

--------------------------------------------------------------------------------

Richard Alan Kramer, Arete Research Services LLP - Senior Analyst [15]

--------------------------------------------------------------------------------

Okay. So you think it's going to be up on what it was last year?

--------------------------------------------------------------------------------

Unidentified Company Representative, [16]

--------------------------------------------------------------------------------

Compared to last year, we, at this point, expecting the similar level of the operating capital ratio, Y-o-Y basis, will be maintained. And this year's results is, we are expecting high-single-digit operating margin in a stable manner.

--------------------------------------------------------------------------------

Operator [17]

--------------------------------------------------------------------------------

The following question will be provided by Nicolas Gaudois from UBS.

--------------------------------------------------------------------------------

Nicolas Gaudois, UBS Investment Bank, Research Division - MD, Head of APAC Technology Research and APAC Technology Strategist [18]

--------------------------------------------------------------------------------

First one, is actually a follow-up on Richard's, on the cash flow cycle. I'm still a little bit confused, if I may. So if I look at the numbers, from Q4 to Q1, basically you added close around KRW 1 trillion of operating profit, sequentially. This position didn't change that much. Your working capital actually was not a big variable in neither quarters. And yet, if I look at the cash flow from operations, in Q4, you had a very small negative, in Q1, you have a very small positive. And we leave the moving parts there are others, which in both quarters are a significant item. In fact, your other line in Q4 is as big as your operating profit, pretty much, 2/3 of your operating profits this quarter. And consequently, I'm wondering what are we missing in the cash conversion cycle? I mean, it looks very unusual cost stream. Again, you had a very strong quarter for operating profit in Q1.

--------------------------------------------------------------------------------

Unidentified Company Representative, [19]

--------------------------------------------------------------------------------

Well, with this kind of complicated question, we need more time to discuss before we answer. (inaudible) actually.

--------------------------------------------------------------------------------

Do-Hyun Jung, LG Electronics Inc. - President, Chief Finance Officer and Representative Director [20]

--------------------------------------------------------------------------------

Thanks for waiting. Again, there isn't that big issues for any transition but all the changes in the system are needed changes. But honestly this quarter is very abnormal cases. And then, in the future, if we have that much of a net operating profit, and the cash flow, of course, improved last. And then, we can turnaround the targeted numbers.

--------------------------------------------------------------------------------

Nicolas Gaudois, UBS Investment Bank, Research Division - MD, Head of APAC Technology Research and APAC Technology Strategist [21]

--------------------------------------------------------------------------------

Okay. But that, that didn't happen. Your operating profit improved massively Q-over-Q and your net operating cash flows barely improved.

--------------------------------------------------------------------------------

Unidentified Company Representative, [22]

--------------------------------------------------------------------------------

Yes. As Do-Hyun Jung has mentioned, it's a little bit not normalized one. For the future, starting from this quarter, the operating margin happened and the cash flow positive number will happen.

--------------------------------------------------------------------------------

Nicolas Gaudois, UBS Investment Bank, Research Division - MD, Head of APAC Technology Research and APAC Technology Strategist [23]

--------------------------------------------------------------------------------

It will be very correlated. Okay, I probably need to follow up. Thanks for that color. I appreciate it. Second question is back to smartphone. So your -- the G6 screen-to-body ratio is quite good. But if you look at the OLED-based phones like the Galaxy S8 or the coming iPhone 8 anniversary model, they will have similar or better screen-to-body ratios. So wondering, is this time for LG Electronics to start rolling out Flex, OLED-based devices in the high end? In particular, your sister company, LG Display, is now deploying Gen 6 capacity, which could actually support this.

--------------------------------------------------------------------------------

Unidentified Company Representative, [24]

--------------------------------------------------------------------------------

As you already know, we have 2 flagship model, which is, in the first half, is G Series, and second half is V series. And what we believe is that in the second half of this year, there will be a plastic, OLED-adopted smartphone that's going to be launched probably in the second half of this year. So we are preparing for the plastic OLED to be adopted in our flagship smartphones, so that we can actually cope with other competitors. And...

--------------------------------------------------------------------------------

Unidentified Company Representative, [25]

--------------------------------------------------------------------------------

We're not confirmed yet, but probably, and it's some possibility, we can adopt pure OLED in our first smartphone, starting 2030. But it's not confirmed yet. Once we confirm internally, we can deliver the message to the market as soon as possible.

--------------------------------------------------------------------------------

Nicolas Gaudois, UBS Investment Bank, Research Division - MD, Head of APAC Technology Research and APAC Technology Strategist [26]

--------------------------------------------------------------------------------

Okay. So it's possible you use that in the second half of the year, and review refresh is what you said, but it's not confirmed yet?

--------------------------------------------------------------------------------

Unidentified Company Representative, [27]

--------------------------------------------------------------------------------

Right.

--------------------------------------------------------------------------------

Nicolas Gaudois, UBS Investment Bank, Research Division - MD, Head of APAC Technology Research and APAC Technology Strategist [28]

--------------------------------------------------------------------------------

Okay. Great. That's for us good news. Thank you for that. And last question is just a clarification. So you have I think earlier alluded to maybe helping Home Entertainment on the TV side, right, for profit? Which makes sense, considering how you've been gradually flexing that mix actually for the last 18 months, there had been profitability. Just one clarification, your LCD and OLED TV ASPs in Q1, respectively, were approximately at what level? We're struggling a little bit to reconcile units and revenues for HE.

--------------------------------------------------------------------------------

Unidentified Company Representative, [29]

--------------------------------------------------------------------------------

Thank you, (inaudible). So we are, actually, it's hard to give a record number for the ASP, but that was like tracking the trend. Of course, we got the better sales for the premium TV, and then, so normally we pattern that ASP is going to increase gradually. However, once you see the right market trend, all the right OLED TV panel, I mean, I'm sorry, as the TV market price is going down. So what's happening, once again, as we get out at the ASP trend, we are -- our ASPs gradually increase, and also if that trend keep going forward, I'm sorry.

--------------------------------------------------------------------------------

Unidentified Company Representative, [30]

--------------------------------------------------------------------------------

As you know, the LCD TV market, I mean, including everything, TV market is already saturated. So to maintain our revenue, we should keep our, at least, we make small off in ASP. That's why we are recently put more focus on the premium portion. Basically, we are delivering the TV business. Our premium portion in TV business is gradually increasing.

--------------------------------------------------------------------------------

Operator [31]

--------------------------------------------------------------------------------

The following question will be provided by Richard Kramer from Arete Research.

--------------------------------------------------------------------------------

Richard Alan Kramer, Arete Research Services LLP - Senior Analyst [32]

--------------------------------------------------------------------------------

Just 2 simple follow-ups. Just calculating some of the numbers in your Mobile business. Obviously, you had a big sequential increase in your domestic market shipments, and also about a 20% increase, which is very strange in the first quarter in your Latin America business, your Central South America business. Typically, when you've seen increases in your domestic market business, they correlate very highly with improvements in profitability. Did the breakeven this quarter come because either you managed to shift your flagships in the domestic market, which is at a very high ASP -- the highest ASP for your group? And how can you be confident enough to shift 20% more phones into a very currency FX-challenged Latin American market right now, if the risk that you're building up channel inventories and that we should expect that the unit shipments next quarter would be flat or potentially down across the whole business?

--------------------------------------------------------------------------------

Unidentified Company Representative, [33]

--------------------------------------------------------------------------------

(inaudible), please.

--------------------------------------------------------------------------------

Unidentified Company Representative, [34]

--------------------------------------------------------------------------------

Regarding your question, for the first quarter, the market for the domestic was pretty much improved compared with the last quarter, because -- mainly because of the G6 shipments that happened in the early March of this year. And also, for the Latin America, we are seeing a little bit of an improvement on the economic situation in those regions. And we, actually, in the back tier though, we did a good sales on the Latin America region. And in the second quarter of this year, probably high-single digit shipment can be increased in the second quarter, because in all the regions in the global manner, all the shipments is expected to grow, because -- mainly, because of the global launch of G6.

--------------------------------------------------------------------------------

Richard Alan Kramer, Arete Research Services LLP - Senior Analyst [35]

--------------------------------------------------------------------------------

Did you think you're going to grow units again on top of the 14.8 million smartphones, you're going to grow them again high-single digits?

--------------------------------------------------------------------------------

Unidentified Company Representative, [36]

--------------------------------------------------------------------------------

Yes. That's right.

--------------------------------------------------------------------------------

Richard Alan Kramer, Arete Research Services LLP - Senior Analyst [37]

--------------------------------------------------------------------------------

But you'll slip back into losses because you have the marketing costs for mobile?

--------------------------------------------------------------------------------

Unidentified Company Representative, [38]

--------------------------------------------------------------------------------

Yes, that's correct.

--------------------------------------------------------------------------------

Operator [39]

--------------------------------------------------------------------------------

The following question will be presented by Mark Newman from Bernstein.

--------------------------------------------------------------------------------

Mark C. Newman, Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst [40]

--------------------------------------------------------------------------------

On the Handset business, given all the restructuring cost you've taken, can you talk about the -- what is the break even scale necessary for the number of smartphones sold? Let's talk about annual basis. If you could talk about, before restructuring, what that minimum scale was? And today, for 2017 and '18, what that minimum scale is? How many millions of smartphones you have to sell in a year to breakeven for the division? And if you want to talk specifically about flagship in that, that would also be helpful.

--------------------------------------------------------------------------------

Unidentified Company Representative, [41]

--------------------------------------------------------------------------------

For the shipment, what we expect for the breakeven point is that compared to last year and this year, the portion of the shipment is not that important. The real thing is that the flagship model portion out of the total shipment of the smartphone is really important. Right now, our level of flagship models are down to around 10% out of the total smartphone shipments. And this should be increased at least more than 20%, then there'll be a breakeven point for the whole year. So having a flagship model shipment for more than 20% is the important number that we expect for the breakeven.

--------------------------------------------------------------------------------

Mark C. Newman, Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst [42]

--------------------------------------------------------------------------------

Well, in that case then, except for the flagship phones, then, the rest of the phones are, therefore, loss-making, and no matter how many you sell, that doesn't improve? That's what that implies.

--------------------------------------------------------------------------------

Unidentified Company Representative, [43]

--------------------------------------------------------------------------------

Of course, for the mass-tier zone, we are making a margin. But compared with the flagship models, it's kind of a little bit lower than the flagship model. So having -- making a shipment for the mass-tier zone is important. But however, on the operating margin side, flagship model is more important compared with the mass-tier zone.

--------------------------------------------------------------------------------

Unidentified Company Representative, [44]

--------------------------------------------------------------------------------

Yes. The problem though, fixed cost, including advertising and marketing, we should raise our revenue to the sole, the premium product portion is very important at this point. And without that premium profits there that even in the mid of the tier, it's kind of difficult to make meaningful sales. That's why we're still focusing our premium model smartphone with lots of costs.

--------------------------------------------------------------------------------

Mark C. Newman, Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst [45]

--------------------------------------------------------------------------------

And I assume then, you're not spending too much marketing costs on the mainstream market also. So that doesn't have so much impact there. Do you have any breakdown you can share in terms of profitability, either gross margin or operating margin between flagship and the mainstream market?

--------------------------------------------------------------------------------

Unidentified Company Representative, [46]

--------------------------------------------------------------------------------

Sorry, but based on the company policy, we are not allowed to disclose the detailed margin for our smartphone. We only provide the dividend break of operating margin, sorry.

--------------------------------------------------------------------------------

Mark C. Newman, Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst [47]

--------------------------------------------------------------------------------

I see. The second area of question for me on -- can you talk about the inventory level? Can you talk about inventory level in the channel for smartphone and TV? I mean, particularly in TV, the results are surprisingly positive, the probability is very, very strong. Even in what's normally a weak quarter and also in previous years, especially coming after a World Cup or Olympics year, you see some weakness at the beginning of the year. Do you allot -- allot time to inventory works? How is the -- can you talk about the inventory level? And is that normal? Is it high? Is it low, for particularly, TV? If you could also comment on smartphone, that would also be useful. But to clarify, when I'm asking about inventory, it's not LG level, I'm talking about in the channels, meaning retail, retailers, et cetera.

--------------------------------------------------------------------------------

Unidentified Company Representative, [48]

--------------------------------------------------------------------------------

Yes. Hopefully, when I talk about the TV inventory in the market channel, probably the inventory level is very low, I think, because here typically as the channel shortening is continuing so far. So even in our company, there was the difficulties in securing the enough retainer in first quarter. So, for instance, my partner's calculation in the market or so, that the inventory level of TV is very low.

--------------------------------------------------------------------------------

Mark C. Newman, Sanford C. Bernstein & Co., LLC., Research Division - Senior Research Analyst [49]

--------------------------------------------------------------------------------

I see. That's very useful. And do you have the number of units? Sorry, if I missed it. The number of units or ratio of OLED TVs versus LCD TVs in last quarter?

--------------------------------------------------------------------------------

Unidentified Company Representative, [50]

--------------------------------------------------------------------------------

The total revenue percent of the UHD and the OLED TV out of the total TV sales, last quarter, was a level of 50%. And then, in addition to that, on second quarter, we expect results to be shown to increase to like close to level of 60%.

--------------------------------------------------------------------------------

Unidentified Company Representative, [51]

--------------------------------------------------------------------------------

Operator, if there are no more questions from participants, I would like to end this conference call.

Again, I would like to thank you for participating in the conference call today. If you have any further follow-up questions, please contact the IR team. Thank you.