Sony Corporation CEO Discusses Q4 2010 Results - Earnings Call Transcript

May.26.11 | About: Sony Corporation (SNE)

Sony Corporation (NYSE:SNE)

Q4 2010 Earnings Call

May 26, 2011 9:00 am ET

Executives

Samuel J. Levenson – Senior Vice President of Investor Relations

Masaru Kato – Executive Vice President and Chief Financial Officer

Analysts

Mark Harding – Maxim Group

Daniel Ernst – Hudson Square Research, Inc.

Yuji Fujimori – Barclays Capital

Operator

Good day ladies and gentlemen and welcome to the consolidated Financial Results for Fiscal Year ended March 31, 2011. At this time, all participants are in a listen-only mode. We will conduct a question-and-answer session towards the end of this conference (Operator Instructions). As a reminder, this conference is being recorded for replay purposes.

I will now turn the presentation over to your host for today to Sam Levenson, Senior Vice President of Investor Relations at Sony Corporation of America. You may proceed.

Samuel J. Levenson

Thank you very much for that introduction Francis. And thank you all for joining us today May 26, 2011 for the discussion of Sony’s fiscal year results. I hope that you were all in enjoying Adele's latest hit while you were on hold.

I am Sam Levenson, Senior Vice President of Investor Relations at Sony Corporation of America. And with me on the conference call tonight is Mark Kato, CFO of Sony Corporation; Robert Wiesenthal, Group Executive, Corporate Development, M&A for Sony Corporation, and EVP and CFO of Sony Corporation of America; and Yoshinori Hashitani VP of Senior General Manager of Investor Relations Division at Sony. Thank you all very much for joining us.

In just a few moments, we will review today’s announcement, then we’ll 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 a 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 am now going to turn to today’s announcements. As we announced in our preliminary earnings results released on Monday, our operating profit for the fiscal year ended March 31, 2011 came in on forecast at approximately ¥200 billion or over six times what we recorded in the previous fiscal year.

We achieved that result despite an approximate ¥100 billion negative impact from foreign exchange combined with the initial effects of the earthquake. Excluding the impact of foreign exchange rates operating income was 9.5 times that of the previous fiscal year. Every reportable segment recorded operating profit for the year. In addition, the game business and Sony Ericsson each concluded the year in the block. At this time the television business is the only remaining key business unit where we still need to stop for operating losses.

As I will discuss in more detail later the losses of the TV business were stable year-over-year despite significant price erosion and unfavorable exchange rates. As we announced on Monday this week, we reported loss from net income attributable to Sony Corporation’s shareholders, we will be reporting an approximately ¥360 billion in evaluation allowances against deferred tax assets. However this evaluation allowance is non-cash charge and has no impact on our cash flow.

Now let’s review the fiscal year results on a segment-by-segment basis beginning with Consumer, Professional & Devices. CPD segment sales increased 2% and sales to outside customers increased 4%. This was primarily due to higher LCD sales resulting from significantly higher unit sales and higher semiconductor sales resulting from favorable performance of small to mid-size LCD panels and image sensors, partially offset by lower component sales resulting from a decrease in storage media and optical disc drive sales.

Operating income in CPD of ¥2.9 billion was recorded, a significant improvement compared to a loss of ¥53.2 billion in the previous fiscal year. This improvement was driven primarily by an increase in gross profit due to higher sales, a decrease in loss on sale disposal and impairment of assets and a decrease in restructuring charges. These factors were partially offset by unfavorable foreign exchange rates and an increase in SG&A as a result of an increase in advertising and promotional expense.

Excluding the restructuring charges, product categories was an improvement in operating results included semiconductors, reflecting an increase in sales of image sensors, and professional solutions, reflecting an increase in sales of products such as digital cinema projectors.

Product categories was a deterioration in operating results in LCD televisions reflecting a decline in unit selling prices and unfavorable foreign exchange rates despite rise in unit sales. Television business sales increased 16% to ¥1,161 billion due to a significant increase in LCD unit sales despite price declines in unfavorable foreign exchange rates.

For the fiscal year LCD TV unit sales increased 44% to 22.4 million units. This significant increase in unit sales came mostly from Japan and other areas including developing countries. Excluding restructuring charges ¥75 billion in operating loss was recorded which was down slightly year-on-year. This was due to significant price declines and the significant impact of unfavorable exchange rates despite the increase in unit sales which I talked about a moment ago along with a reduction in raw material costs and the benefits of restructuring.

Turning next to Networked Products & Services segment. NPS sales increased 0.4%. This was due primarily to an increase in PC sales, as increased unit sales and market share in all regions more than offset unfavorable exchange rates.

Operating income in NPS of ¥35.6 billion was recorded a ¥119 billion improvement, when compared with the operating loss recorded in the previous fiscal year. This improvement was mainly due to a significant improvement of the cost of the sales ratio coupled with an increase in gross profit resulting from higher sales partially offset by unfavorable exchange rates.

Excluding restructuring charges the category which favorably impacted the change in segment operating results was the game business, reflecting significant PS3 hardware cost reductions and higher unit sales of PS3 software. Game sales decreased 5% year-on-year to ¥798 billion, this was primarily due to the impact of unfavorable exchange rate.

Operating income improved ¥103.5 billion year-on-year to ¥46.5 billion. This significant improvement was primarily due to PS3 hardware cost reductions, higher unit sales of PS3 software resulting from hit titles, such as Grand Turismo 5, and contribution from game accessories such as PlayStation move, despite the negative impact of exchange rates. As we go forward, we're steadily working on NGP the Next Generation Portable device, which we will introduce later this year.

The next is the Picture segment. Sales decreased 15% in yen and 8% on the U.S. dollar basis. Operating income decreased 10% in the yen and was almost flat year-on-year on the U.S. dollar basis. The decrease in sales was mainly due to unfavorable exchange rates and a significant decline with international theatrical and worldwide home entertainment revenues partially offset by an increase in television revenues. Operating income decreased primarily due to the appreciation of the yen against the dollar.

Sales in the Music segment decreased 10% and operating income increased 7%. Sales decreased because of the negative impact of the appreciation of the yen against the dollar, the especially strong performance of Michael Jackson product in the previous fiscal year and the continued contraction of the physical music market. Despite the decrease in sales operating income increased due to a decrease in marketing, restructuring and overhead costs.

Next is the Financial Services segment. Although policy amount in force at Sony Life continue to grow steadily, financial services revenue decreased approximately 5% due to deterioration in net gains from investments at Sony Life. The stable amount of operating income ¥118 billion was recorded, but this was 27% lower than the previous fiscal year primarily due to lower net valuation gains from investments as the previous year benefited from the significant recovery of the Japanese stock market.

Sales at our equity affiliate Sony Ericsson declined 7%. This decrease was due to a decline in unit shipments as a result of a focus on high-end smartphones and a reduction in the size of product portfolio.

Income before taxes of €134 million was recorded for the current year, a €787 million improvement when compared with the loss before taxes of €654 million in the previous year. This significant improvement was mainly due to the positive impact of a rise in the average selling price, a favorable product mix, and an improved cost structure as well as the benefit of lower restructuring charges in the reversal of warranty reserves. As a result, Sony recorded equity and net income at Sony Ericsson of ¥4.2 billion for the current fiscal year compared to a loss of ¥34.5 billion in the previous fiscal year.

Next, I would like to briefly outline our forecast for the fiscal year ended March 2012. For the current fiscal year our assumptions for foreign currency exchange rates are approximately ¥83 to the U.S. dollars and approximately ¥115 to the euro. We're pleased to note that even after taking into account the impact of the earthquake, we’re expecting sales to grow 4% year-on-year and operating income to be basically flat year-over-year.

The forecasted earthquake impact is ¥440 billion on sales, and ¥150 billion on operating income. In addition, our forecast includes an estimated ¥14 billion of currently known cost associated with the unauthorized access to our networks. In order to reduce this impact, we’re implementing various initiatives all of which are incorporated into an operating forecast of ¥200 billion.

Almost to all of the ¥150 billion impact is expected to be incurred in electronics and we expect nearly every product category to be impacted. Categories with the largest impact are TV, digital cameras and components. The timing of the impact on our results will depend on the product category. In the television business, the impact will be comparably small in the first quarter, because we have parts and inventory, but it will be felt in the second and third quarters.

In the digital camera business, we expect a large impact in the first quarter and a mitigation of that impact in the second quarter. The impact on components will be mainly in the first half of the fiscal year, but some impact will remain in the third quarter. Overall, the impact will diminish as we go through the year, with the impact being the largest in the first and second quarters and some remaining in the third quarter in categories such as TVs and components.

Restructuring charges recorded within operating expenses are expected to be ¥25 billion compared to ¥67.1 billion recorded last year. Equity in net income of affiliated companies for the March 2012 fiscal year is expected to be approximately ¥15 billion as compared with ¥14.1 billion in the previous year. Income before income taxes is anticipated to decrease, mainly due to gains on sales investment securities and net foreign exchange gains recorded in the March 2011 year.

Net income attributable to Sony Corporation stockholders for the March 2012 fiscal year, is expected to be approximately ¥80 billion compared to the loss recorded in the previous fiscal year. For more detailed information on our forecast by business segment, please see today’s earnings release.

So, before we turn to questions, I’d like to offer just a very brief summary. For the year just ended operating profit increased about ¥170 billion. This despite a ¥100 billion impact from foreign exchange, as well as the initial impact of the earthquake. This significant increase in earnings was driven by improvements in Networked Products & Services, Consumer Professional and Devices and from Sony Ericsson. If we look back over the last two fiscal years, our operating profit has improved by ¥428 billion again despite foreign currency headwinds.

For the current fiscal year ended March 2012, we believe we can effectively mitigate the enormous effect of the earthquake that is anticipated over the first three quarters and complete the year without any decrease in our operating profit. In addition, at this time, we believe that we will record a modest sales increase year-over-year, positive cash flow and positive net income attributable to shareholders.

At this time, I’d like to open up the lines for questions. Operator, if you would make a call please.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). Our first question is from the line of Mark Harding from Maxim Group. Please proceed.

Mark Harding – Maxim Group

Okay, thanks for taking my question. Firstly, if you looking back at 2010, could you help me understand some of the moving parts as it relates to TV pricing? Perhaps the mix of low-end versus advanced TVs and then BRIC versus developed countries?

Masaru Kato

Okay. Well, compared to the plan that we originally had in our budget, we did experience some mix in the TV category. I will give you some examples. We expected to do about 10% of our output in 3D TVs, this turn out to be a little bit less. The bulk of a high-end product in the LED backlit TVs, this proportion is slightly lower than we had expected. And in terms of inch size, I think the lower inch size around 32-inchs which is a more affordable price product, a proportion of those kind of rose a little bit by compared to our original projections. Is that okay with you?

Mark Harding – Maxim Group

Yes. That's perfect. And then looking at the TV guidance, it looks pretty strong at 20%. I think the industry is looking for about 13% and given the headwinds of the end of the Eco-Points program, what gives you that level of confidence that 20% is achievable?

Masaru Kato

Okay. Various things I guess, as you said, if you look at the Japanese domestic market the Eco-Point subsidy has ended. So we are going to expect a decline in the Japanese market. When we turn to North America and European markets, again here maybe a flat or even a decline in the market maybe seen, but what is driving the unit numbers here, is the so-called emerging markets including the BRIC countries where we’re expecting a lot of growth. And we intend to follow that growth in those areas and we’re investing in marketing to make sure that we do catch our fair share of the market.

Mark Harding – Maxim Group

Okay, it’s fair enough. And then I guess as lastly when you look at your overall revenue guidance with the backdrop of the impacts of the earthquake, if you exclude out the ¥440 billion earthquake related hit to sales it looks like revenue growth would be about 10%. That seems very high. I was wondering, if you could also sort of comment on what gives you that’s that level of confidence that 20% is achievable?

Masaru Kato

Okay. Various things I guess, as you said if you look at the Japanese domestic market the Eco-Points subsidy has ended. So we are going to expect a decline in the Japanese market. When we turn to North America and European markets again here, maybe a flat or even a decline in the market maybe seen, but what is driving the unit numbers here is the so-called emerging markets including the big countries, where we’re expecting a lot of growth. And we intend to follow that growth in those areas and we’re investing in marketing to make sure that we do catch our fair share of the market.

Mark Harding – Maxim Group

Okay, fair enough. And then I guess just lastly, when you look at your overall revenue guidance with the backdrop of the impact of the earthquake, if you exclude out the ¥440 billion earthquake related hit to sales. It looks like revenue growth would be about 10% that seems very high. I was wondering if you could also sort of comment on what gives you that level of confidence.

Masaru Kato

Okay. I think you have the same question related to operating profit as well.

Mark Harding – Maxim Group

Yeah.

Masaru Kato

Now, we have said that the impact of the earthquake in terms of revenue is ¥440 billion and operating profit ¥150 billion. Now adding back those numbers to the fiscal 2010 projections that we have described is not the right math. The impact of the earthquake is basically the decrease in sales caused by the earthquake meaning that the supply chain is severely damaged, and from the supply-side, we will not be able to meet the initial projections that we had. This is the impact of the earthquake.

Now do we standstill there. No, we are implementing various initiatives such as, if the supply is limited, we will review our pricing strategy, for example. We will review our product lineup. We will realign products, so that we can build those products based on the limited key components that we have.

On top of that, we will be reviewing our marketing spend because if you don’t have enough quantity to sell no body is going to spend that kind of marketing money we had in the budget in the first place. So all those adjustments or initiatives are incorporated in the final operating profit or the sales numbers that we have given to you. So it’s not correct to add back those numbers onto the forecast that we have given you. So, in concept the actual numbers would be slightly less if there were no earthquake at all.

Mark Harding – Maxim Group

Okay. Okay, I appreciate that. Thank you.

Operator

Our next question is from the line of Daniel Ernst from Hudson Square Research. You may proceed.

Daniel Ernst – Hudson Square Research, Inc.

Yes, good evening. Thanks for taking my call. Three questions, if I might. First, could you walk us through some of the mechanics in the ¥130 billion impact? Obviously a large part of that’s coming from reduced sales, but what part of that is coming from higher procurement costs, if you have to go outside of your own supply, internal supply chain for products and margin implications? If you could sort of walk us through the mechanics of and composition of that ¥150 billion.

And then looking at the forecast for the Network Product Group, which has significant reduction planned for operating income because of the reduced sales of high margin PS2 and PSP sales. Can you tell us, does your forecast or can your forecast withstand a reduction in the PS3 selling price? And then last question, excluding the impact from the earthquake, what is the outlook for the LCD business margins? Thanks.

Masaru Kato

The ¥150 billion impact of the earthquake. This is again a reduction in sales due to the supply constraints. So it does not include impact of costs for example, not, for us not achieving the cost down targets that we had planned. Those are a different set of numbers, which are included in the ¥200 billion operating profit numbers, but I am sorry, we do not disclose category for all, in detail how the improvements have been incorporated.

Talking about NPS declining operating profit projected for the coming about the new current fiscal year. Yes it is, you’re correct in that PS2 now in its 12th year profit contribution still decline although it's a nice piece of business, yes. Same is true with portable PSP, which we introduced in 2004, so I think its seventh year.

On top of that, we have made some adjustments due to the impact of the intrusion into our network system. We have said that with, assuming some well, I'd say expenses would be incurred. Given information we have so far, the estimated impact would be about ¥14 billion. Now, those are included in the numbers.

Now as far as PlayStation 3 is concerned, profit contribution is expected to rise because we expect more good sales on the software side. I cannot talk about pricing of our PS3, I’m sorry.

Samuel J. Levenson

Dan, we weren’t quick enough to write down your third question, what was that again?

Daniel Ernst – Hudson Square Research, Inc.

The third question was if you were to exclude the impact from the earthquake, what is the outlook? What are the going forward trends for margins in the TV business, operating margins?

Masaru Kato

Okay. Now, TV business, when we started planning for the new fiscal year, again we had an objective target of reaching break even. Now as you know, we have not been profitable for the last seven years. But again, we aimed for break even. But with this unfortunate happening, the earthquake, now our target to meet that number has become very difficult. But I know compared to year-on-year, the losses expected would be squeezed to a considerable extent. I cannot give you any numbers, but the improvement in the TV business will come in the form of reduced losses, which is not an ideal situation, but we are seeing progress. We hope to see progress this year.

Daniel Ernst – Hudson Square Research, Inc.

Understood. Thank you.

Operator

(Operator Instructions) Your next question is from the line of Yuji Fujimori from Barclays Capital. You may proceed.

Yuji Fujimori – Barclays Capital

Yes, thank you very much for taking my question. I want to ask about the inventory situation, two things. One is it looks like the March end inventory was larger than expected mainly due to the earthquake impact. And if you can quantify the impact, could you let us know?

And secondly, if you have any outlook for the inventory situation in the end of Q1 or Q2, that would be appreciated. And also, just following up a question, I could understand Kato's explanation about the operating profit impact from the earthquake, but then I couldn't fully understand the revenue impact. So even after factoring into the earthquake impact, you are expecting 4% revenue growth this year. And due to the price competition in the TV space or very modest volume loss for business with cameras, I think 4% growth seems to be a little bit stressed.

So are there any new product contributions such as tablets, any [GP] in your forecast, or the price increase impact could be much larger than I am expecting? So could you make up the following supplementary comment on the top line growth of 4% this year? Thank you very much.

Masaru Kato

Fujimori, I will try to answer your questions as much as I can. Now, on the inventory situation, I said that compared to initial expectations, level of inventory March ended slightly higher. Now, this is a sort of a general comment. It differs category by category. I said overall, this higher than expected inventory is not an unmanageable situation or a negative impact to our business going forward.

But if you, if we break down the inventory, for example, TV business inventory was a little bit high because in Japan, March is the last month of the eco-points subsidy. And not just us, but many manufacturers are expecting the last minute rush to the stores for televisions, which did happen but not to the extent that we had projected. And that was the major reason for the inventory buildup. This is nothing related to earthquake itself. Now, the other side of it, which is related to the earthquake is that we could not ship products to some areas.

But I cannot give you category-by-category breakdown of inventory, I’m sorry. Inventory level, after end of the first quarter, second quarter, here on paper we do have projections because we have calculated impact of the earthquake. But whether those projections are correct, I think we need to see how it actually evolved. But one thing we can say or give light to the situation is that in some categories where we will foresee shortage for quite some period, we will be allocating the purchase product that we have. So we will not be selling everything when we have a purchase order for it, those come into play.

Secondly, we are trying to get hold on the parts to build the products. But as you know, if we are missing one single part, we will not be able to assemble the final product. So that will have another impact on how well we do in securing our key devices.

Other factors, well, not just the direct impact of the earthquake onto parts supply, but things like power outages that are expected, they maybe not in the first quarter, but in the summer season, the government has given guidelines to reduce electricity consumption by 15%. Those things come into play.

So I know I'm not answering your questions, but what I’m trying to say is that all those factors would affect how our inventory will be at the end of each quarter. But I don't think it will be in a situation where we have tons of inventory. I think we will be scrambling for more products to meet demand of our customers.

Third question, yes, we do, the logic I explained for operating profit regarding impact of earthquake and pre-earthquake projections, I think, applies to revenue as well. Now, given that we know shortages in some areas of key components, we will redesign products, we will change the line up of product or the mix of the products. So that would ultimately determine the revenue line and the 4% growth is a result of both timing by the digital additional provisions.

Yuji Fujimori – Barclays Capital

Thank you very much for the color. The one additional question is at the Japanese briefing meeting, Kato-san commented the panel, an LCD panel production yield program has resulted in the new product introduction in Q4. So that kind of impact was financially meaningfully big for the inventory pileup or the TV loss?

Masaru Kato

Okay, Fujimori, before we go to this, I’ll say these things. Let me add a little comments to the third question on the revenue side. If you take product category-by-category and see where the growth comes from, one thing it’s TV as we explained. We were projecting higher units of 27 million. Unit price might go down, but compared to our 23.4 million output for the past fiscal year, we have seen quite an increase in units. So the TV is one driver.

Second, we are aiming for higher quantities in PC. Digital cameras, especially in the single-lens reflex category and our game software, those are by category, as we mentioned, of the breakdown of the increase from the revenue side. Now, on LCD, I think the impact on inventory of the lower-than-expected yield on LCD production, it’s a mix, it looks both ways because if the yield were high and if we could sell, okay. But what we did was, with the uncertainty of the new panels coming in, we had to go to second sources to make sure that we could build something, okay.

So in a sense, you could say that we held inventory of costs, maybe not double of that, some excess inventory so that if one source did not deliver what we had accepted, we could build with other sources. So the answer to your question is yes, but the amount of inventory involved in that category, I don’t think that’s a major component of the unexpected rise (inaudible).

Yuji Fujimori – Barclays Capital

Okay. Thank you very much.

Samuel J. Levenson

Francis, we have time for one more question if you have one.

Operator

(Operator Instructions)

Samuel J. Levenson

Well, having received no questions, Francis, we’re going to end the call here. Thank you all for participating. And just to remind you that the contact information for the IR offices in Tokyo, London and New York are in the press release. So please feel free to reach out to us on any other questions. Thank you so much for joining us.

Operator

And ladies and gentlemen, thank you all for your participation in today’s conference call. This concludes the presentation, and you may now disconnect.

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