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Executives

Edward Reid

Masaru Kato - Chief Financial Officer, Executive Vice President, Corporate Executive Officer, Director and Member of Compensation Committee

Analysts

Daniel Ernst - Hudson Square Research, Inc.

Richard Kramer - Arete Research Services LLP

Kota Ezawa - Citigroup Inc, Research Division

Sony (SNE) Q3 2012 Earnings Call February 7, 2013 8:00 AM ET

Operator

Welcome to the Sony Corporation Third Quarter Fiscal Year 2012 Conference Call for Overseas Investors. My name is John, and I'll be your operator for today's call. [Operator Instructions] Please note that this conference is being recorded. I will now turn the call over to Edward Reid. Edward, you may begin.

Edward Reid

Thank you very much for that introduction, John. And thank you, all, for joining us today, February 7, 2013, for the discussion of Sony's third quarter results. We hope you have all enjoyed music from 2CELLO's new album on Sony Masterworks, IN2ITION, while you're on hold. I'm Edward Reid from the Investor Relations department here in Tokyo. And with me on the conference call tonight is Mark Kato, CFO of Sony Corporation; Steven Kober, Executive Vice President and Chief Financial Officer, Sony Corporation of America; and Yoshinori Hashitani, VP, Senior General Manager, Investor Relations division of Sony.

Thank you very much for joining, us all of you. In just a few moments, we will review today's announcement and then we will be available to answer your questions.

Please be aware that statements made during the following remarks and Q&A session with respect to Sony's current plans, estimates, strategies, press release and other statements that are not historical facts are forward-looking statements about the future performance of Sony. These statements are based on management's assumptions in light of the information currently available to it and therefore, you should not place undue reliance on them. Sony cautions you that a number of important factors could cause actual results to differ materially from those discussed in the forward-looking statements. For additional information as to risks and uncertainties, as well as other factors that could cause actual results to differ, please refer to today's press release, which can be accessed by visiting www.sony.net/IR.

Let me remind you that the webcast replay of the Investor Meeting held earlier today, along with the slides presented at that meeting and our detailed earnings release, are available on our website for your access.

With that, I'm now going to turn to today's announcement. I shall begin by explaining the consolidated results for the third quarter ended December 31, 2012. Consolidated sales increased 7%, primarily due to the consolidation of Sony Mobile and higher sales in the Pictures and Financial Services segments.

If Sony Mobile had been consolidated in the previous year, consolidated sales would have been essentially flat year-on-year. The Pictures and Financial Services segments are performing quite well, with sales of Pictures up 30% and Financial Services up 21%, both significant increases.

Operating income of JPY 46.4 billion was recorded, a JPY 138.1 billion improvement compared to the JPY 91.7 billion operating loss recorded in the same quarter of the previous fiscal year. This improvement was primarily due to the contribution of the home entertainment and sound segment where a JPY 63.4 billion impairment loss on shares of S-LCD was recorded in the same quarter of the previous fiscal year and where improvement in the profitability structure of LCD TVs is progressing smoothly. The mobile products and communication segment also contributed to the improvement due to the recording of a JPY 33 billion valuation allowance on certain deferred tax assets at Sony Ericsson in the same quarter of the previous fiscal year and an increase in unit sales of smartphones.

In addition, the Devices segment, which had a significant increase in sales of image sensors and the Pictures segment, which had a significant increase in motion picture revenues, also contributed to the improvement in operating results.

Income before income taxes of JPY 29.4 billion was recorded, an improvement of JPY 135.3 billion compared to the JPY 105.9 billion loss recorded in the same quarter of the previous fiscal year. JPY 25.9 billion of income tax expense was recorded during the quarter. Since we continue to record valuation allowances against deferred tax assets, primarily in Japan and the U.S., the effective tax rate for the quarter exceeded the Japanese statutory tax rate. Net loss attributable to Sony Corporation's stockholders decreased JPY 148.2 billion year-on-year to JPY 10.8 billion.

I will now explain our forecast for the fiscal year ending March 31, 2013. Assumed foreign currency exchange rates for the fourth quarter are approximately JPY 88 to the U.S. dollar and JPY 150 to the euro. The consolidated sales forecast for the fiscal year ending March 31, 2013 remains unchanged from our November forecast of JPY 6,600,000,000,000. This is due to the favorable impacts of the depreciation of the yen, as well as the higher-than-expected Financial Services revenue in the third quarter being offset by downward revisions in annual unit sales forecasts of several key electronics products, resulting from the stagnation of the electronics device market and intensification of competition in all regions.

The consolidated operating income forecast for the fiscal year remains unchanged from the November forecast of JPY 130 billion. This is because lower-than-expected results of the electronic segments are expected to be offset primarily by higher-than-expected Financial Services revenue in the third quarter and with planned asset sales. I refer you to our earnings release for a discussion of the results of each business segments compared to the previous fiscal year. And I will now briefly touch on how each segment's third quarter operating results compare to our November forecast and explain our revised fiscal year forecast.

In the Imaging Products and Solutions segment, operating results were approximately JPY 10 billion below our November forecast. The Game segment's operating income for the quarter was approximately JPY 5 billion below our November forecast. In the mobile products and communication segment, operating results for the quarter were approximately JPY 5 billion below the November forecast due to the decrease in PC unit sales. The Home, Entertainment and Sound segments operating results for the quarter were approximately JPY 5 billion above our November forecast. In Television, things are improving faster than our November forecast. While unit sales and revenue were impacted by our emphasis on establishing a profitable foundation and by price decline, our actions have resulted in operating loss improving significantly even excluding the impact of the impairment of shares in S-LCD the previous year.

In the Devices segment, operating income for the quarter was in line with our November forecast. Total inventory for the 5 electronic segment as of December 31, 2012, was lower than at the end of the previous quarter but about 20% higher year-on-year, primarily due to the consolidation of Sony Mobile. Excluding this impact, inventory is slightly heavy having increased approximately 9% year-on-year and we aim to reduce it by the end of March.

Sales and operating results for the current fiscal year are now expected to be below the November forecast in each of the 5 electronic segments because the annual unit sales forecast for key electronics products other than smartphones and home use game consoles have been revised downward. Compared to the previous fiscal year, we expect sales to be essentially flat but operating results to improve. We continue with our plans to keep on improving profitability structure in televisions as we aim to turn a profit in the fiscal year ending March 31, 2014.

Next is the Pictures segment. Segment operating income for the quarter was approximately JPY 5 billion above our November forecast. Fiscal year sales for the segment are expected to exceed the forecast. This is primarily due to the depreciation of the yen. The outlook for operating income remains unchanged. Sales and operating income are expected to increase year-on-year.

In the Music segment. Operating income for the quarter was in line with our November forecast. Fiscal year sales and operating income for the segment are expected to be unchanged compared to our November forecast. Compared to the previous fiscal year, we expect sales and operating income to be essentially flat.

Next is the Financial Services segment. Segment operating income for the quarter was approximately JPY 5 billion higher than our November forecast. Fiscal year sales and operating income for the segment are expected to exceed our November forecast because of the recording of higher Financial Services revenue and operating income than our November forecast in the current quarter. Sales are expected to increase year-on-year and operating income is expected to decrease.

That ends my discussion of the results and forecast. I will now turn things over to Kato San and Steve for Q&A. John, may I ask you to queue up the questions, please?

Question-and-Answer Session

Operator

[Operator Instructions] And our first question is from Daniel Ernst from Hudson Square Research.

Daniel Ernst - Hudson Square Research, Inc.

Kato San, I have 3 questions that all relate to profitability, if I might, by segment. First, on the television business, while there is market improvement from when we recorded a loss this time last year, we're still not on a real path to profitability. If you could walk me through the confidence we have in having profits next fiscal year, what does that model look like? Is it further model cap reduction? Is it more outsourcing? What has to happen to get that division to profitability knowing that sales prices continue to be under pressure around the world? And then second, looking at the imaging business where we used to make good profits on camcorders and digital cameras, now even in a peak quarter, this year, and this time last year, we're producing losses. What is the trajectory of that business profitability? Are we going to end up like in the TV business where we're in sort of a perma-loss position? Or is there a plan to regain profits despite the fact that those markets, on a unit basis

[Audio Gap]

In division, if we look back 7, 8 years ago at the end of the last game cycle, the PlayStation 2 division was generating nice profits. It was at about 6% margin in the year ending March '05 before we headed into the loss category when the PS3 was launched. Here, we're looking at maybe a breakeven or slight loss for the fiscal year. And we're apparently going to enter a new cycle sometime in the near term. What are the prospects for maintaining profitability in Game division? Or are we going to have a similar to prior cycles where we're going to sort of a deep loss in the early stages of Game?

Masaru Kato

Okay. Let me answer your question one by one. First, on television. Now almost 2 years ago, when Kaz Hirai became responsible for this business, at that time, and this is fiscal year '11, and that's fiscal year ending March 2012, our loss in this business is roughly JPY 160 billion. Now at that time, he said that he would turn around the business by the end of next fiscal year, which is fiscal year 2013, fiscal year ending March 2014. Now on the way to turn around, he said that for the current fiscal year, he would aim to cut the losses in half, JPY 80 billion. Now we are on that trajectory at the moment. Now how did we get here? Basically, first, we tackled our issue of the cost of the panels, which were the biggest component of the overall cost. And as you know, last year we dissolved the relationship we had with Samsung. Now this produced immediate results. And that is one big factor that have produced positive results towards a better profitability. Second, we have taken initiatives to reduce our fixed cost. That is another big area. So -- and going forward, continuing on this path of reducing our costs and SG&A, et cetera, next year, we aim to introduce products that can command a higher margin for us. Now competing in a very price competitive market is not the main strategy that we're taking. This year, as you know, we have not pursued unit volume. Unit volume means we have to compete in very low-margin markets, very low-margin product lines, which we think would not help us this year. So we have deliberately cut down on the number of units we aim to sell but rather concentrate on profitability. Now next year, based on a better profit, I would say, better cost structure, we aim to increase unit volume where possible. And combined with high-quality products that differentiate against competition, for example, stuff like 4K TVs that we introduced at CES. Those are the things that we are looking to further improve the TV profitability. And hopefully, by the end of the next fiscal year, do better than breakeven. Now DI, I must say at the beginning, although the segment IP&S, Imaging Products and Solutions produced a negative operating margin, now the Digital Imaging consumer product area, we are not in red ink even for the third quarter. But it is true that a lot of businesses in the low-end digital still cameras have shifted to smartphones. Now here, what we intend to do is to concentrate more on the high-quality, high-end product within this segment. In order to do that, how do we do that? We have very high technology in image sensors, in lenses and signal processing semiconductor technology. We have all these component technologies in-house. And we would like to come up with product that will draw more attention from consumers who are interested in added value product. That's one aspect. The other is that yes, consumers are shifting from digital still cameras to smartphones. Smartphone cameras are pretty good, but as you know, we have invested in mobile phone business mainly by taking the remaining shares from the Sony Ericsson joint venture and made it our wholly-owned subsidiary. If we increase the share in the mobile phones, that means that we are kind of capturing the consumers who have shifted from these wholesale cameras to mobile phones. So that's another aspect. And third, if you take the imaging business in a broader sense, including image sensors, we have a good component business in image sensors and we can capture upside here as well. Okay. In order to just give you a better picture of how the imaging product and solution sector is been up [ph], the -- we do have some difficulty here in the professional solutions group as well. So as the segment as a whole, we have negative OP this third quarter, but it is mainly due from the professional solutions group, not the digital imaging consumer products that I have talked about. Thirdly, gaming. Now one thing clear for us that in terms of profitability, we have to do a better job in promoting the PlayStation Vita mobile product. How do we do that? Well, gaming business software is the name of the game. So as a fundamental measure, we are putting all -- a lot of resources, not just first party, but also asking third parties to put out more attractive software. That's the basics. The other thing, well, marketing, pricing of the product, et cetera, I cannot talk about pricing of this platform, but those are the things that we are looking into to improve our profitability in the mobile handheld gaming business. Now PS3, in its sixth year, I think it still has a long life. And here, we're not in the stage where we are losing money in the hardware anymore. So again, there are discussions about the next platform, I cannot dwell on that at all at the moment. But in any case, we have a lot of business in PS3. Now to give you an indication of how, well, stable this business is, although we have reduced forecast on many of our product lines from television, digital still cameras and, et cetera, but mobile phones and home game devices, we have not changed the forecast on these for this fiscal year. So that I hope will give an indication of our confidence in this platform going forward. That's a lot to answer and maybe I could not cover everything, but I hope it addresses most of your questions.

Operator

Our next question is from Richard Kramer from Arete Research.

Richard Kramer - Arete Research Services LLP

I've just got 2 questions. The first one is can you help us understand the relative profitability between PCs and smartphones in your mobile business and in your, well, in that segment because we're -- clearly, there's a divergence of directions in those 2 businesses in Mobile Products & Communications. And I'm just curious, which of the product areas really caused the losses and if there's a big difference there? And also, in the Devices business, clearly, the attach rates for high-quality megapixel sensors, CMOS sensors on smartphones are rising sharply. In other areas of the supply chain, we have seen suppliers talk about restricting CapEx and looking to increase pricing. Can you talk about, in areas like image sensors or batteries, whether you would invest aggressively to boost capacity because you think there's shared gains or you might restrict capacity investments so that you could look to increase pricing since demand remains very robust and you guys are market leaders in CMOS sensors?

Masaru Kato

Okay, the first question mobile products and communication, between PCs and smartphones, what's the breakdown of the profitability. Okay. These are, well, different markets as we see it today. There are similarities conversions. But the straight answer to your question is that of the losses that we are incurring this quarter, the losses on the PC side is a little bit heavier than what we anticipated. It's a simple answer, but I hope it answers your question. The story is quite different. Now on the PC side, one unexpected event that happened for us is the introductions of Windows 8. As we all know, there's less talk of Windows 7 at the time of introduction of Windows 8. That kind of took out the gas out of the introductory kit here. Second, from our side, if you look at the market geographically, sales in China, the market itself is not growing as expected. That was, on a territorial geographical basis, the downside on the PC business. Smartphones, losses, yes, but here, we are improving our business structure. We have taken steps to turn around the business, restructuring, changing the workforce, allocation of functions on a global basis. Now this is now a 100% wholly-owned subsidiary. We have put in a lot of our technology to come up with a new product. To give you an example, the Xperia Z that we are going to introduce this spring, that we showed up at the CES, Consumer Electronic Show, got very good reviews. So there's a lot to be hopeful going forward. And from a business side, our shift to smartphone have raised our average selling price of the product in the business. So those are the good stuff that we are looking forward in the mobile business. Your second question is Devices. Now I cannot dwell on our pricing strategy, but just to give you a kind of the sense of direction where we are going on image sensors. Now we wrote in the market for smartphones, tablets, high-end cameras, this means that the market is growing in the segment that we have superior product. So what we are doing right now is to invest in fabrication capacity so that we can gain from whatever uplift there is in the market.

Richard Kramer - Arete Research Services LLP

Okay. And just as a follow up on the smartphone business, you made a comment in the outlook about some concerns about losses in the coming -- in the end of the year. You said operating results expected to deteriorate significantly due to the remeasurement gain. But can you talk about the structural profitability of that business long term, and also, how it reflects upon the piece that sits in between PCs and smartphones in your approach to tablets?

Masaru Kato

Okay. The smartphone business, again, no, we are putting in all the cutting-edge technology that we have in image sensors, in battery and in everything. So that will result -- will kind of maintain the average selling price. Second, the markets we serve today, well, Japan, the domestic market is a very good market for us. We are trying to regain foothold in the European markets. And then after that, we aim to expand our footprint across the rest of the globe. So that -- combined with technology, higher margins and geographical expansion, that is the basics of our strategy going forward. If you look at our mobile business, it ranges from, I'll just say, smartphones, tablets and PCs and other mobile devices. Now all these products, we're not silos anymore. We have not been silos for quite some time now since Howard Stringer and Kaz. And all of these product divisions are coordinating their efforts because the market is converging. And if one segment grows, we have a broad range of mobile products to serve whatever market -- whichever market grows. So if PC is good, we have our VAIO product. If it's not and it's shifting toward tablets, we do have our tablets. Now just for your information, our tablet development group has been shifted from the former PC group to the mobile group, the Xperia group. So again, there's a kind of a smooth transition between smartphones and tablet if the market moves into that direction. I hope I'm answering your question.

Richard Kramer - Arete Research Services LLP

Yes. And I guess the last question is will the tablet strategy be based around the Windows 8 that we see coming in PCs? Or will it be based around the Android, which is entirely the basis of the smartphone business and therefore, if you do Windows 8 tablets, would you also do Windows 8 smartphones?

Masaru Kato

Okay, here, I cannot talk about specific products. But in general terms, what I have said 2 minutes ago is that we have the range, Androids or Windows 8 or whatever. And within this broad range, we will follow the market.

Operator

[Operator Instructions] The next question is from Kota Ezawa from Citigroup.

Kota Ezawa - Citigroup Inc, Research Division

I have 2 questions. Number one is how much actually you cut off the operating profit guidance in electronics division from your November guidance? And also, how much you picked up, the profit guidance in the Financial business and then asset divestiture from November guidance? Sorry, can you answer one-by-one?

Masaru Kato

Yes, one-by-one. Ezawa San, I'm sorry, I cannot give you specifics by segment, by name. But one thing is very clear. On the electronic side, our performance, for me, is below expectations. Now we have given indication of this in the form of reduced sales projections in many of our categories. Exceptions are mobile phones, which is going to be our core business. Another exception is the PS3, home console, gaming business. And one other thing that I would like to mention is TV, although we have reduced numbers for TVs. Now these reduced number does not negatively reflect on profitability. As you know, we have shifted from pursuing volume but rather concentrate on profitability. So without giving you numbers, the downward impact of the revision against November forecast is, I have to say, quite severe. But for this current fiscal year, we will make up the losses. One thing is the exchange rate is moving towards our favor. That will offset some. The others, we have plans to -- of asset sales. We have a long list, and we shall continue to review these so that for this fiscal year, we will produce the projected profits that we have announced today, which is the same as November forecast. Now, last word on this subject. I cannot give you straightforward numbers, but just to give you the flavor of where these downward forecast are taking place, now just to give you kind of sequence of order. Now the biggest hit was in the Information -- sorry, Imaging Product and Solutions. Next, Mobile products and Communications, next, it is Home Electronics and Sound, followed by Devices and Game. So that's the magnitude, the sequence of the magnitude that we have to revise our profit projections next year.

Kota Ezawa - Citigroup Inc, Research Division

Okay. As a follow up for this question, can you say this asset divestiture, you already have some projection in your November guidance. So can we say this asset divestiture profit contribution you actually picked up the contribution in the latest -- this time in your guidance?

Masaru Kato

Okay, let me explain this way. Now we are looking into various opportunities to divest or asset sales. Now since these -- we have negotiations or business partners, et cetera, so we cannot give you concrete names or whatever. But those that we have decided, concluded and announced are included in the forecast. For example, the 550 Madison U.S. headquarters, the gains from this was partially included in the November forecast. The deal was not closed at the moment, so it was only a projection. We signed the contract, proved to be a little bit higher than the November projections, but all those were included. For other assets, I cannot be specific, but we are looking into various opportunities.

Kota Ezawa - Citigroup Inc, Research Division

Okay, that's understandable. The other question is you said JPY 100 billion like operating profit improvement for next fiscal year by LCD TV and the handset loss-making division turnaround. And also the restructuring costs, which you have JPY 75 billion in the guidance, you said it will be smaller in March '14. Assuming JPY 130 billion profit guidance for this fiscal year, is it -- you mean that Sony can achieve well above JPY 200 billion operating profit target in March '14 straightaway?

Masaru Kato

Yes, Ezawa, that's the obvious question I was expecting from you. But to be very frank, I think it is a little bit premature to give you a number. We are working on a budget at the moment. The guidance or the indication I gave you, I gave the audience this afternoon, was taking parts of the business where improvement can be expected. Now television, if we hit breakeven, that's an improvement of JPY 80 billion. Mobile phones, we are incurring losses. If we do better than breakeven, we are expecting to do better than breakeven. So between TV and mobile, I said if we do our job right, the improvement would be more than JPY 100 billion. To repeat for the audience that were not present at the Investor Meeting in Tokyo this afternoon, I also said that restructuring cost would be less than this year, which is expected to be JPY 75 billion. Now one other thing that I did mention was the impact of the exchange rate. Now we cannot count on exchange rates. But suppose the current rates continued throughout the year, the uplift would be quite considerable. So those are the elements that I touched upon. But at this point, I'm not going to give you a number, the overall operating profit. But I hope I can communicate to you that all the measures that we have been taking so far in restructuring, in reforming the business, in reshuffling our business portfolio, improvement in product, television, mobile and everything, we are quite confident that we can produce better results than this fiscal year in electronics business.

Operator

And that was our last question. I'll turn it back over to Edward for any closing remarks.

Edward Reid

Thank you very much, John. We'd like to thank you all for joining us today to discuss the announcement. Please feel free to contact our London, New York or Tokyo Investor Relations offices if you have any further questions. Thank you, all, for joining us, and good night from Tokyo.

Operator

Thank you, ladies and gentlemen. This concludes today's call. Thank you for participating. You may now disconnect.

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