Sony Corp. (SNE) CFO Kenichiro Yoshida on Q3 2015 Results - Earnings Call Transcript

| About: Sony Corporation (SNE)

Sony Corp. (NYSE:SNE)

Q3 2015 Earnings Conference Call

January 29, 2016 8:00 AM ET

Executives

Justin Hill – General Manager of Investor Relations

Kenichiro Yoshida – Executive Deputy President and Chief Financial Officer

Kazuhiko Takeda – Senior Vice President and Senior General Manager

Steven Kober – Executive Vice President and Chief Financial Officer

Analysts

Kendrick Chia – Tahan Capital

Operator

Welcome to the Sony Corporation Conference Call for Overseas Investors for the Third Quarter Ended December 31, 2015. My name is John, and I will be your operator today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Please note this conference is being recorded.

I will now turn the call over to your host, Justin Hill.

Justin Hill

Thank you very much, John. Good morning, good afternoon and good evening. Thank you, all, for joining us today, January 29, 2016 for a discussion of Sony's results for the third quarter ended December 31, 2015. We hope you enjoyed Adele's 25 while you were on hold.

I am Justin Hill, General Manager of Investor Relations at Sony Corporation, returning as moderator of this conference call after a nearly 12-year hiatus. Tonight, here in Tokyo, I am joined by Kenichiro Yoshida, Executive Deputy President and CFO of Sony Corporation; Kazuhiko Takeda, Senior Vice President and Senior General Manager of Sony's Corporate Control Department; Steven Kober, Executive Vice President and Chief Financial Officer, Sony Corporation of America.

In just a few moments, Yoshida-san will make some short remarks, and then Takeda-san will provide you an explanation of our forecast. After that, we will take your questions.

Please be aware that during the following remarks and Q&A, statements made 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 meetings, which we held earlier today along with the slides presented at that meeting and our detailed earnings release, are available on our website for your access.

I will now turn things over to Yoshida-san for his remarks.

Kenichiro Yoshida

Thank you, Justin. Before turning things over to Takeda-san for a summary of our focus, I want to share with you my view of the state of Sony's electronic business today. I will touch on Sony Branded Product business, our Device business and our Game & Network Services business.

First is Branded Product business, which is defined as our Mobile Communications, Imaging Product & Solutions, and Home Entertainment & Sound segments. These segments contain our smartphone, camera and television businesses. I am very pleased with how these branded products are performing. All three segments recorded a year-on-year increase in operating income in the third quarter.

Their performance helped Sony to record the highest level of third quarter consolidated operating income and net income since the third quarter of the fiscal year ended March 2008. This was primarily due to the significant cost reductions we undertook at our sales company and headquarters last fiscal year. And due to our strategy of not chasing share, we like to emphasize profitability. The improvement in the results of these segments can also be attributed to the quick decision-making of the management team. For example, the managers of these businesses moved quickly to reduce our exposure in emerging markets when performance there [indiscernible]. They also moved quickly to reduce advertising and promotion expenses when immensely became tight.

Another part that which have helped to improve result in the branded products business is a fact that we grow our sales and marketing organization in 1% last year. They still have increased the speed of our decision-making. Although the mobile business is projected to record a loss this fiscal year, these results are improving because it is following the same strategy as our other branded products.

Going forward, we plan to focus on the premium segment of the branded products market. And we believe that by doing this, we can generate a healthy return despite using very little invested capital. We are taking a conservative view as to the market for these products next fiscal year. We believe that the sales in emerging markets could decrease due to a slowing of the economies and the reduction in consumer purchasing power resulting from the depreciation of their currencies against the U.S. dollar. As a result, we believe it is appropriate for us to take this view so as to mitigate downside risk.

Next is the Devices business. We believe that demand for our devices could decelerate in the near term. In our image sensor business, we have changed our forecast to assume a slowdown in the growth of the market for smartphones. In fact, there's a risk that the market for high-end smartphones might decrease due to the issue in emerging markets I just mentioned.

In light of this situation, the management team of Sony is taking quick action. We have instructed our sales team to more aggressively approach smartphone makers, particularly those we had to turn away last year when we were supply-constrained. We have made the decision to postpone our plan to reach production capacity of 87,000 warehouse per month by the end of September 2016.

Finally, we are seriously considering utilizing a portion of our facility in Oita we bought from Toshiba to manufacture logic instead of photodiodes which could lead to a reduction in the cost of our sensors. Although we are taking these actions so as to mitigate the downsized rate in this business, we are confident that in the long-term prospects of image sensors, because we think there is room to expand their use in [indiscernible] cameras, automobiles and the Internet of Things.

We also believe that one of our competitive advantage in the image sensor space comes from the fact that we manufacture the sensor in-house. Thus, we believe that the investments we have made in production capacity for sensors will be variable going forward. We take very seriously the fact that we recorded an impairment in the battery business this quarter. And the possibility that we might have to have record impairment in the camera module business in the future.

We are working hard to right size the part of the battery business devoted to smartphones and encouraged by the part of the business which is devoted to power tools and at the high-output appliances. The possibility that we might have to impair assets in our camera module business comes from problems we had when we're starting up this business. And the decrease in projected future demand from high-end smartphone makers.

The third and final area I want to touch on is Game & Network Services business. This business has great momentum and it's different from our branded Product and Devices business because it is increasing its service-related revenue. The installed base of PS4 hardware is expanding faster than any of our previous consoles. Sales of the product during the holiday season were extremely strong, and network revenue for the third quarter increased approximately 50% year-on-year.

The PlayStation is steadily growing into a global network entertainment platform due to the power of the PlayStation 4 hardware console and the ability of our team to bring vast content creators to the platform. We're excited about the prospects of the PlayStation VR, which is also being well-received by content creators.

On Tuesday, we announced that we would be combining Sony Computer Entertainment and Sony Network Entertainment into a single company known as Sony Interactive Entertainment. The headquarters of the new company will be based in the United States. Many of our key partners across the networks, network services, content and technology are based in the United States. And major shifts in the digital content landscape are happening fast in the U.S. Locating our headquarters there will allow us to quickly respond to the rapidly changing business environment and continue to expand and strengthen the PlayStation business.

This concludes my assessment of the state of our Electronics business today. I thank you for your attention. And we'll now ask Takeda-san to explain our forecast.

Kazuhiko Takeda

Thank you, Yoshida-san. I would like to take a few minutes to explain our forecast for the remainder of the fiscal year ending March 2016, and provide you a little more color on what is happening in our Devices segment.

Our forecast for consolidated sales, consolidated operating income, and net income remain unchanged from the forecast we announced last October. Although we increased our operating income forecast for the Home Entertainment & Sound, Music, Game & Network Services, and Imaging Products & Solutions segment, we reduced our forecast for the Devices segment. We also reduced our contingency budget contained in all other corporate and elimination from ¥80 billion to ¥30 billion.

In the Mobile Communications segment, we have downwardly revised our full year unit sales forecast from 27 million to 25 million units. But our forecast for operating income is unchanged. Despite the reduction in unit sales, we think we can maintain the same level of profitability of the previous forecast by maintaining prices at a higher level than originally planned and by reducing cost.

In the Game & Network Services segment, we have upwardly revised our fiscal year operating income forecast by ¥5 billion to ¥85 billion pursuant to the strong momentum of the PS4 platform. We have been especially pleased with the strong performance of network sales which have been outperforming our expectations.

In the Imaging Products & Solutions segment, we have upwardly revised our operating income forecast by ¥5 billion to ¥63 billion due to a projected improvement in product mix.

In the Home Entertainment & Sound segment, we have upwardly revised our operating income forecast by ¥13 billion to ¥38 billion due to a reversal of certain sales incentive accruals, cost reductions and an improvement in product mix.

In the Devices segment, we have downwardly revised our forecast by ¥82 billion to ¥39 billion due to a decrease in expected sales from our image sensor, camera module and battery businesses, as well as a ¥30.6 billion impairment charge against fixed assets recorded in battery business.

At the briefing we gave to analysts and investors in Tokyo earlier today, we showed two slides that provide a visual breakdown of Devices segment operating income between image sensors, camera modules, batteries and other. You can view these slides in the replay of the Web cast on our IR Web site.

The first slide shows that image sensor business is expected to generate approximately the same amount of operating income this fiscal year and last fiscal year, although, we originally expected the business to generate more operating income than the prior year. Lower-than-expected sales will likely cause the level of profit to be flat year-on-year.

The slide also shows that battery business, the camera module business and the other are expected to generate a loss this fiscal year, with the losses from the battery business and camera module business increasing year-on-year.

The second slide shows the trend in results for these four categories on a quarterly basis for last fiscal year and the current fiscal year, including our forecast for the fourth quarter. Last fiscal year, we received larger orders than expected in image sensor business. This cause our ability to supply the market to be constrained, a situation that continued through the beginning of current fiscal year.

Then, in the summer of 2015, we had an issue with our production equipment, which resulted in our having to decline orders from the 13 customers. After we resolved this production issue and after new capacity had just come online orders from our customers started to decline due to softer end-user demand for smartphones. Further complicating matters were the fact that we supply custom design sensors to some of our major customers, and there is an approximately five-month lead time to manufacture our sensors. As a result, it is difficult to switch our products in line over the other customers quickly. We believe that image sensor business will start to recover from the first quarter of next fiscal year, but we will formulate our business plan based on an assumption that growth of the smartphone market will slow.

In the Music segment, we have upwardly revised our forecast by ¥10 billion to ¥84 billion due to an increase in sales of recorded music and visual media and platform categories. As of this quarter, we have started to disclose the breakdown of our digital revenues in recorded music category between downloads and streaming. Nearly, one quarter of revenue of the category came from streaming. This disclosure can be found in the supplemental data for the Entertainment businesses that we disclosed on our website. We made no changes to our Pictures and Financial Services segment forecast this quarter.

Thank you for your attention. I will now hand things over to Justin.

Justin Hill

Thank you very much, Takeda-san. I'm now going to turn things over to John, so we can start the Q&A session. John, would you please queue up the questions?

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question is from Kendrick Chia from Tahan Capital. Please go ahead.

Kendrick Chia

Hi. I have two questions. First question is – in the first half, you said that you have ¥20 billion of FX buffer and I think ¥60 billion of non-FX buffer. So, I would like to check the update. How much buffer is there left for this quarter respectively for FX and non-FX and how much buffer did you use for 3Q including – and is it used for the battery impairments? So, that's my first question on the buffer.

Second question is on Image Sensor outlook. I understand you said that Image Sensor will recover from 1Q of next year and you think that the smartphone market would slow down. I would like to check with you whether this is the same between the image sensor as well as the camera module portion of the business. Also, would it be worse than the previous year given that you're seeing slowing down? But is it going to be a decline or what we can have like a small group or what? And could you also break down the factors? Is it the price or the volume or is the utilization rate of your production plants? Thanks.

Kenichiro Yoshida

Thanks for the question. Our first question is about risk buffer. You asked Takeda-san to explain about that. And as for the second question, it's image sensor outlook. Well, let me answer the question of the second one. Well, we expect to make some recovery in first quarter in fiscal year 2016 because we already have orders for that. And as I said, we are expecting now almost no growth in the smartphone market. And currently, May application for the smartphone – May application for the [indiscernible] smartphone. So, I think we are currently conservative about the prospect of the fiscal year 2016.

However, currently, we are aggressively doing the promotion of the image sensor business particularly for the Chinese player which we lost when our production is constrained. So, at this moment, we are in the middle of the budget process. So I cannot specify the prize of worrying over utilization as this point in time. And as for the question asked, I think from the [indiscernible] about that question. With regards to your question about fourth quarter risk buffer, we have ¥30 billion in buffer this time in fourth quarter and as opposed to ¥80 billion in the previous quarter. Of ¥80 billion of buffer in the third quarter announced, we used ¥30 billion for the impairment losses for the battery business in third quarter. That's when we do not have and we do not have any exchange rate risk in fourth quarter. So all ¥30 billion is backup for fourth quarter is for businesses.

Kendrick Chia

Can I just ask a quick follow-up question to that. Why did you use the FX buffer for 3Q because your FX assumptions, isn't it more favorable that the yen is stronger versus your assumptions. So why do you need to use the buffers for 3Q?

Kenichiro Yoshida

Sorry. Let me clarify. We didn't use ¥20 billion of buffer in third quarter. We didn't use?

Kendrick Chia

Okay. Which means you have ¥20 billion buffer for left, as well as ¥30 billion for others, correct? So, you have total of ¥50 billion now for 4Q.

Kenichiro Yoshida

No, no. We have only ¥30 billion in buffer in fourth quarter.

Kendrick Chia

You've said you used up ¥20 billion for 3Q?

Kenichiro Yoshida

No. No. We didn't use ¥20 billion buffer because the exchange rate went better than we expected for the buffer purpose.

Kendrick Chia

Okay. Okay. So, you didn't – okay. Okay. Plus ¥10 billion. So, what would the ¥30 billion of others be used for in 4Q? What other possible scenarios they could be used for?

Kenichiro Yoshida

Yes. We projected a lot of risk scenario in our forecast in processes. And one of the area is that the potential impairment loss for the camera module business.

Kendrick Chia

Would that ¥30 billion – I'm sorry, I'm just asking another question. Would it be enough? Would the ¥30 billion be enough? Because looking at your camera module business, the maximum impairment seems to be much – could be more than the battery impairment. So, would the ¥30 billion be more than be enough for that?

Kenichiro Yoshida

At this point of time, we just mentioned that there's a possibility to have impairment changes in the fourth quarter for module business. So, we do not – we are not able to give you any number for the impairment losses at this point of time.

Kendrick Chia

You've said that its 15% of the device is long-lived assets, so would that be ¥60 billion? So that would be more than your ¥30 billion buffer like doing your domestic [indiscernible]?

Kenichiro Yoshida

Yeah. At this point, again, I repeat that we do not comment on the exact number for the impairment at this point of time. So, the ¥30 billion buffer in the other segments include module business impairment and other business segments.

Kendrick Chia

Okay. Thank you.

Operator

Thank you. [Operator Instructions] And we have a question from [ph] John Uchiki from CRF.

Unidentified Analyst

Yeah. Hi. I'm just wondering on the capacity cutbacks for the targets for the [indiscernible] sensor. Was it 87 – could you give us a rough estimate of where that's going? And how are you deciding that capacity build? And you mentioned there's a five months lead time so that goes into production ramp for most vendors for the rest of the year. So, could you provide any additional clarity into the order activity prospects that you're seeing currently? Are you positively inclined about winning back some of the Chinese customer market share?

Justin Hill

So, [ph] John. It's Justin. Let me just make sure I got your two questions – two or three questions, right? The first one you asked was about the 87,000 wafer a month capacity forecast that we have for [indiscernible]. Correct me if I'm wrong but I think you're wondering how that capacity will trend going forward. Is that right?

Kenichiro Yoshida

Yeah. You said that you're going to cut back on that capacity target. So, I'm just wondering what the new target is and how you frame that.

Justin Hill

And then the other was just our kind of visibility into orders at this point in time and our confidence in getting back customer market share from Chinese customers.

Kenichiro Yoshida

Exactly.

Kazuhiko Takeda

Okay. I appreciate the question. Well, in capacity, we have a plan to increase our capacity to 87,000 by September this year and approximately 20% of that capacity increase here so-called half portion. So, currently we are evaluating the current production and I think the production adjustment would be quite concentrated in that 20% portion. However, we haven't decided whether we will reduce or we will change the current planned expansion [indiscernible] at this point in time.

Kenichiro Yoshida

And as for the visibility of customer orders as of to-date, as you may know, with Chinese customers basically tends to have too modest a year. So, we have some confidence that we can ask some Chinese customers quite through. However, these Korean players basically, they release once a year. So, it may take some time to get orders from those players.

Unidentified Analyst

Okay. Thank you. Do you have thoughts from dual camera adoption over the next one to two years and the impact from some of these operations?

Kenichiro Yoshida

Well, for next year, our so-called dual lens – dual camera platform will be launched by, we believe, from major smartphone players. However, as I said previously, recently, our smartphone market is growing and particularly, our high-end smartphone market is now slowing down. So, that may impact the demand or production schedule of dual camera smartphones by the major smartphone manufacturers. So, we believe the real start, the takeoff of smartphone with dual lens camera will be in the year of 2017.

Unidentified Analyst

Okay. Thanks. And on the camera module side, could you talk a bit more about the reasons behind the restructuring and impairment charges? And then going forward into next year, post the battery and camera market restructuring, once that's done, can you talk a bit about, like, what the expectations are outside of [indiscernible] within devices about the profitability? Where do you think that that will go? Do you think you can get those to close to break-even, and how much impact that would have?

Kenichiro Yoshida

And lastly, outside of Devices, are there any large foreseen restructuring expenses that might be incurred going into next fiscal year, or should the restructuring charges come down dramatically?

Unidentified Analyst

Sure. Did you say restructuring in devices?

Kenichiro Yoshida

Well, battery.

Unidentified Analyst

Oh, okay. Battery.

Kenichiro Yoshida

Yeah, and camera modules, right, impairments?

Unidentified Analyst

Oh.

Kenichiro Yoshida

Yeah.

We don't necessarily term those restructuring, but I understand what you're saying.

Unidentified Analyst

Okay.

Kenichiro Yoshida

So, you're – yeah.

Unidentified Analyst

Charges – impairment charges/restructuring expenses. Restructuring expenses, I guess, in mobile impairments and device are rather large, clarity on the mobile, the module impairment charges? And then going into next year, impairments and restructuring charges can we expect those to come off dramatically?

Steven Kober

I'll answer this question. As for the batteries, we already made impairment of the asset. Other than that we don't see a big restructuring charge in this category at this point in time. Our strategy in the battery business is to focus on the part of business where we are strong, that's in [indiscernible] type, and shrink the part of the business where we are weak, laminate type for smartphones.

And as for the modules, as you may know, we are a newcomer in this business. And two years ago, we started this business. However, at the beginning, we had failed to supply the initial product. And after that, we are gradually improving our production itself. And now we are keeping very high yield level. At this moment, the forecast for the smartphone business itself is now declining. That's why we explained about the possibility of the impairment of the module.

And as for the size or timing of the impairment of the module, at this point in time, we cannot comment on that. But as Takeda-san said, approximately a little bit less than 15% of the Device asset is in module. Thank you.

Operator

[Operator Instructions] And we have [ph] John back online with a question. Please go ahead.

Unidentified Analyst

Yeah. Hi. I just had a quick question on the Mobile Com business going into next year. The targets have been for trying to achieve breakeven. Is that broadly on track? And can you give us any further details some of the actual actions that you've taken or are finishing up through this quarter to get to that path for breakeven?

Kenichiro Yoshida

Yeah. Thank you. I think we are on track for the breakeven of fiscal year 2016. Well, we are currently focusing the products and area and countries and telecom carriers. And also we are conducting quite significant restructuring and that is on track and we believe we have a good chance to achieve breakeven next fiscal year. Thank you.

Unidentified Analyst

Thanks. And Music, are there any new parts on streaming now that you're breaking it out? Is that having a positive impact on revenue growth and recorded music? And looking forward into the next year or two, do you think that trend will continue or accelerate? And is that a net positive or what is the impact for Sony's business?

Kenichiro Yoshida

Well, again, thank you for the question. Well, we are having a quite significant momentum in the music streaming. And because of that, we see signs that the music market is finally bottoming out due to the rise of streaming services such as Spotify and Apple Music after 15 years of decline. Do you have any add-on comments?

Kazuhiko Takeda

No. We're very positive with the growth in the streaming market. To some extent, it's replacing the download business, but the growth is positive. We expect it to keep going and accelerate. So, as Yoshida-san said, we expect the Music business to be on the rise again.

Kenichiro Yoshida

Thank you.

Unidentified Analyst

Okay. Thanks.

Operator

[Operator Instructions] And we have a question from Kendrick Chia from Tahan Capital.

Kendrick Chia

Hey. Can I check your ¥50 billion of upward revision for the all other segment? What is it for? ¥49 billion, sorry.

Kenichiro Yoshida

Yes. We talked earlier in the third quarter, we put ¥80 billion of risk buffer in other segment. And this time, we put only ¥30 billion for that progress so, that improved the other segment in this quarter. Thank you.

Kendrick Chia

Okay. Okay. Can I ask a follow-up question on the restructuring costs for mobile, as well as the other segments? Is there a possibility that 4Q restructuring costs could be more than last year which was quite massive?

Kenichiro Yoshida

Yes. Thank you for asking a question about restructuring charge in fourth quarter compared to the previous year. As you know, we had massive restructuring activity in last fiscal year. But in this year, we have only big exercise in Mobile Communications segment. And therefore, in the fourth quarter in this fiscal year, we expect that has a sizeable restructuring charges for the Mobile Communications segment. But we do not expect a large one other than the Mobile Communications segment. Thank you.

Kendrick Chia

Thank you.

Operator

[Operator Instructions] Thank you, ladies and gentlemen. As we're running out of time, I would now like to hand – we will now close the call. Thank you for participating, and you may now disconnect.

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