Vtech Holdings Limited (303) Earnings Call Transcript & Summary

Good afternoon, ladies and gentlemen. Today, VTech Holdings Limited is announcing its annual results for the year ended 31st of March 2020. Due to COVID-19, this year, we are holding the presentation by live webcast from our head office in Hong Kong. Let me introduce the management here. From the left, Mr. King Pang, Executive Director and Group President; Mr. Allan Wong, Chairman and Group CEO of VTech Holdings; Mr. Andy Leung, Executive Director and CEO of Contract Manufacturing Services; and Ms. Shereen Tong, Group Chief Financial Officer. First of all, Ms. Tong will present the group's financial performance. Next, Mr. Leung will review the group's operations. Then Mr. Pang will give the management outlook for this financial year. We will finish our presentation with a Q&A session. Please submit your question anytime through a text box at the lower right-hand corner of your screen. Now may I invite Ms. Tong to open today's presentation. Ms. Tong, please.

Thank you, Grace. Good afternoon, ladies and gentlemen and all viewers online. First of all, I would like to share with you the financial highlights of the group for the year ended 31st of March 2020 compared with the same period of the last year. As you see from the slide, the revenue of the group rose by 0.2% to USD 2,165.5 million. The increase in revenue was mainly driven by the higher sales in Europe and Asia Pacific, which offset the decrease in revenue in North America and Other Regions. The gross profit of the group rose by 4.3% to USD 663.6 million. And our gross profit margin also increased from 29.4% to 30.6%. The increase in operating -- gross profit and gross profit margin was mainly due to the lower material prices, while direct labor costs and manufacturing overheads benefited from the depreciation of the renminbi against the U.S. dollar. Our operating product rose by 13.7% to USD 219.7 million, and our operating profit margin also increased from 8.9% to 10.1%. The increase in operating profit and operating profit margin was mainly due to the increase in gross profit and gross profit margin, which offset the increase in total operating expenses. The operating profit for the financial year 2020 also include a favorable gain of USD 5.9 million, on an investment in a company that design and distribute integrated circuit products, while the gain on disposal of tangible assets of USD 5.9 million was recorded in the last financial year. Our profit attributable to shareholders rose by 11.3% to USD 190.7 million, and our net profit margin also increased from 7.9% to 8.8%. As a result, our basic earnings per share rose by 11% to USD 0.755, and our Board of Directors has proposed a final dividend of USD 0.36, putting the total dividend per share for the year to USD 0.53. Turning to the revenue by region. North America remains the largest market of the group, accounting for 45.7% of the group's revenue. Our sales in North America reduced by 0.5% to USD 989.6 million. The decrease in revenue was mainly due to the lower sales of our telecom products and contract manufacturing services, which offset the higher sales of our electronic learning product. Our sales to European market rose by 0.4% to USD 886.3 million. The increase in revenue was mainly due to the higher sales of our contract manufacturing services, which offset the lower sales of our electronic learning products and telecom products. In Asia Pacific region, the revenue of the group rose by 4.3% to USD 259.4 million. The increase in revenue was due to the increase in sales of our electronic learning products and contract manufacturing services, which offset the lower sales of our telecom products. Other Regions include Latin America, Middle East and Africa. The gross revenue in Other Regions reduced by 15.9% to USD 30.2 million. The decrease in sales was mainly due to the decrease in sales of our telecom product and electronic learning product, which offset the higher sales of our contract manufacturing services. Our stock balance as of 31st of March 2020, increased from USD 369.9 million to USD 372.6 million. Our stock turnover days also increased from 100 days to 102 days. The highest stock level was mainly due to the reduction of shipment arising from the outbreak of COVID-19. In addition, many of the group suppliers in Mainland China did not resume production immediately following the extended Chinese New Year holiday, leading to the disruption in the supply chain and the shipment of the group's product. Our trade debtor balance as of 31st of March 2020 reduced from USD 263 million to USD 221.5 million. And our trade debtors turnover days also reduced from 65 days to 63 days. Our financial position remains very strong. We are debt free. And our net cash balance as of 31st of March 2020, compared with the same period of last year, increased from USD 237 million to USD 242.5 million. That's all my presentation. I will now invite Mr. Andy Leung to share with you our operation review. Mr. Leung, please.

Thank you, Shereen, and good afternoon to you all. Thank you very much, indeed, for joining us. I will now take you through the review of our operations. I will start with the impact of the COVID-19. As for many business, the COVID-19 pandemic has caused disruptions to VTech in both supply and demand for products. On the supply side, in Mainland China, the long Chinese New Year holiday in January 2020 was extended. Factories were required to resume work in phases. Furthermore, many suppliers extended their shutdowns, causing interruption to material supply in February and March. In Malaysia, production at our facilities for CMS customer ceased from mid-March 2020 when country imposed a movement control order to lower the spread of the virus. With the easing of lockdown measures, our production capacity in Mainland China and Malaysia began returning to normal in April. On the demand side, most of the group major markets have been in different levels of lockdown since late January 2020, adversely affecting shipment across all our businesses. Looking at costs. We can see that the group gross profit margin in the fiscal year 2020 increased to 30.6% from 29.4% in the previous fiscal year. Material prices were lower and direct labor costs benefited from the depreciation of the renminbi. Manufacturing overhead remained stable. Tension on trade between U.S. and China remained with us. On January 15, 2020, a Phase 1 trade deal was signed between China and the U.S. 15% tariff that was imposed on VTech residential cordless telephone from September 1, 2019, was reduced to 7.5%, effective February 14, 2020. A number of the group CMS customers have also been affected by the tariffs, ranging from 7.5% to 25%. As of today, all but a few ELPs are exempt from the U.S. tariffs. Now let me turn to the details of our operations, starting from North America. Group revenue in North America decreased by 0.5% to USD 989.6 million in the fiscal year 2020. Higher sales of ELPs were insufficient to offset lower revenue of telecommunication products and CMS. North America remained the largest market of VTech, accounting for 45.7% of the group revenue. ELP revenue in North America rose by 3.6% to USD 493.7 million, driven by higher sales of both LeapFrog and VTech stand-alone products. The group gained market share overall, mainly due to the strong performance in Canada, where VTech overtook the competition to become the #1 supplier in infant and toddler toys category. As a result, we strengthened our leadership as the #1 manufacturer of electronic learning toys from infancy through toddler and preschool in the U.S. and Canada. In stand-alone products, the growth of LeapFrog learning toys was particularly robust. The brand benefited from higher sales of infant, toddler and preschool product as retailers increased shelf space. Good sell-through of items carrying overt educational value, especially LeapFrog Learning Friends 100 Words Book and 2-in-1 LeapTop Touch also boosted growth. The newly launched interactive building sets, LeapBuilders, saw solid sales as retailers gave support to the range. For the VTech brand, preschool product and Kidi line achieved higher sales, driven by the success of items such as Myla the Magical Unicorn, PJ Masks Learning Watch and Kidi Star Karaoke Machine. This growth offset declines in infant and toddler products, KidiZoom Camera and the Go! Go! Smart family of products. In platform products, both LeapFrog and VTech brands registered lower sales. LeapFrog saw a further decline in sales of children's educational tablets, offsetting the contribution from the newly launched handheld gaming system RockIt Twist and Magic Adventures Globe. During the fiscal year 2020, the line-up of LeapFrog reading platforms was expanded through the introduction of LeapStart Go. The latest version is a sleek, easy-to-hold stylus that triggers videos and audio responses, helping children aged between 4 to 8 years old to learn. As a result, sales of the LeapFrog reading system were stable, reinforcing the group's dominance in the reading category. For the VTech brand, lower sales of KidiBuzz offset higher sales of KidiZoom Smartwatch and Touch & Learn Activity Desk. Our partnership with Netflix, the animated series Go! Go! Cory Carson, premiered in January 2020. The response has been good. A range of playsets and vehicles based on the Go! Go! Cory Carson characters reached the shelves in U.S. in March 2020. LeapFrog Academy is steadily growing its subscriber base. Once again, our ELP won numerous prestigious awards from the industry and consumer organizations. Among those key ones in the U.S., 5 VTech and LeapFrog products were finalists for the 2020 Toys of the Year Awards. We have 2 products inside the list of Walmart Top Rated by Kids in 2019. In Canada, we also had products named to Walmart's list of Top Toys for 2019. Telecommunication products revenue in North America declined by 7.4% to USD 243.9 million, with lower sales of residential phone, commercial phone and other telecommunication products. In residential phones, sales contribution decreased in the fixed-line telephone market contract further. However, the rate of decline moderated as the group became exclusive supplier to a key U.S. retailer. In fiscal year 2020, VTech gained market share and maintained our #1 position in the U.S. residential phones market. For commercial phones and other telecommunication products, sales of SMB phone, hotel phone, headsets and baby monitors were lower, offsetting growth in Voice-over-IP phone and conference phone. Our ranges of SMB phone have reached the end of its life cycle, leading to a reduction in sales. Hotel phone faced a pressure of a very competitive marketplace. Sales of headset products fell because of an existing customer with excess inventory. This was partially offset by a new customer's launch of a mobile phone station. Baby monitors experienced an overall sales decline, as a number of customer reduced orders. Nonetheless, in the fiscal year 2020, VTech gained market share and retained our position at the #1 baby monitor brand in the U.S. and Canada. The award-winning Snom product contributed to the overall growth in Voice-over-IP phone. CMS revenue in North America was 1% lower at USD 252 million. The decrease we saw mainly from the growth in professional audio equipment and medical and health products being offset by lower sales of industrial and communication products. Professional audio equipment grew as backlog of orders for a customer cleared as a result of an improvement in the materials supply. Another customer increased order as they benefited from a new product launch. Growth in medical and health products was driven by higher sales of hearing aids. This came as a customer decided to transfer its in-house production of finished products rather than just PCB assembly to VTech. Sales of industrial products fell on lower orders for note-counting machine and electronic locks. Sales of communication products declined as the customer's product reached the end of its life cycle. The solid-state lighting business meanwhile remained stable. Turning now to Europe. Group revenue increased by 0.4% to USD 886.3 million in the fiscal year 2020 as higher CMS sales offset lower revenue from both ELP and telecommunication products. Europe was the VTech's second largest market, accounting for 40.9% of the group revenue. ELP in Europe declined by 3% to USD 333.3 million. The European markets were affected by the weakness of the European currency, the lingering effect of the Toys"R"Us bankruptcy and the financial difficulties faced by smaller retailers in the region. Sales of both stand-alone and platform products were lower. Despite this, VTech remained the #1 infant and toddler toys manufacturer in France, the U.K., Germany, Spain and Belgium. In stand-alone products, sales of VTech brand products were down. Lower sales of infants and toddler products, the Toot-Toot family of products and the Kidi line offset growth in preschool products, KidiZoom Camera and Switch & Go Dinos. A new range of interactive animal playset called ZoomiZooz was introduced to the key markets in Europe and was well received. Sales of the LeapFrog stand-alone products increased, led by rising sales of infant, toddler and preschool products. Bla Bla Blocks which is the name we use in Europe for LeapBuilders, saw sales decrease. Platform products' record sales decreased. Higher sales of LeapFrog products were insufficient to compensate the lower sales of VTech products. In the LeapFrog plan, growth was driven by new product launches, including Magic Adventures Globe, RockIt Twist and LeapStart Go. This offset sales decline in children educational tablet and the LeapFrog reading system. The sales decline for VTech platform product was led by lower sales of children's educational tablet, KidiZoom Smartwatch and KidiCom Max. Sales of Touch & Learn Activity Desk remained steady. Revenue from telecommunication products in Europe decreased by 6% to USD 112.5 million in the fiscal year 2020. Sales of residential phone continues to decline, offsetting the growth of commercial phone and other telecommunication products. Residential phones saw sales decline due to the continuous contraction of the fixed-line telephone market and as a result of reduced orders from a number of existing customers. The sales growth in commercial phones and other telecommunication products was mainly driven by CAT-iq headsets and CareLine range. Sales of CAT-iq headsets were boosted by addition of a new customer in Germany and the start of shipment to a major telecommunication operator in the U.K. The CareLine range saw increased order from several existing customers. Conference phones recorded modest growth. The Voice-over-IP phone, baby monitors and hotel phone business were stable, but sales of IADs were lower as a customer reduced orders. CMS revenue in Europe grew by 5% to USD 440.5 million, with sales increase in most of the major product lines. Hearables benefited from the good sell-through of existing products and a new project launch at a major customer. The growth of professional audio equipment was supported by a backlog of orders for a major customer being cleared and another new generation of product seeing strong demand. Sales of Internet of Things products, such as Internet-connected smart thermostats and air-conditioning controls grew as a customer shifted all production to VTech. There was also stable demand for smart meters. Medical and health products saw revenue growth from hearing aid. This was a result following the decision by the customer to allow VTech to manufacture finished product rather than only handle PCB assembly. A new customer in the field of hair removal products added to the growth. Home appliance sales rose and market demand improved from key customers. In communication products, production of network routers for an existing customer was ramped up. Switching mode power supplies, however, registered a sales decline as expected. Next Asia Pacific. Group revenue increased by 4.3% to USD 259.4 million in fiscal year 2020, as higher sales of ELP and CMS offset lower sales of telecommunication products. The Asia Pacific region rose to account for 12% of the group revenue. Revenue from ELP in Asia Pacific grew by 2.5% to USD 83.2 million, led by the growth in Australia, Korea and Japan. In Australia, the group benefited from the broader listings and more shelf space at major retailer, all of which supported strong sell-through for both VTech and LeapFrog branded products. Growth in Korea was driven by higher sales of LeapFrog products. In Japan, the group benefited from the relaunch of the VTech brand in a major toys retailer. In Mainland China, sales declined due to the outbreak of COVID-19 in the final quarter of the fiscal year 2020, resulting in lower sales in offline channels. The group's footprint in the Asian markets was strengthened by opening a VTech's flagship toy store on Lazada.com in Malaysia. Telecommunication product revenue in Asia Pacific declined by 21.2% to USD 27.9 million, with decreases in most of the markets within the regions. Sales rose in Hong Kong, driven by increased order for IAD from an existing customer. In Australia, sales fell as lower sales of residential phones offset higher sales of baby monitors. Sales in Japan were affected by a customer's financial situation. Excess inventory at one customer led to lower sales in Malaysia. CMS revenue in Asia Pacific increased by 12.3% to USD 148.3 million. Higher sales of professional audio equipment was able to offset declines in medical and health products, home appliances and communication products. Growth in professional audio equipment came with a full year sales contribution from DJ equipment business against an 8-month contribution in the fiscal year 2019. Medical and health products were affected by decline in orders for diagnostic ultrasound systems. Slow market demand resulted in sales decline for home appliances. Sales of communication products fell as the group's marine radios customer began a transition to a new generation of products. Finally, group revenue in Other Regions comprising Latin America, the Middle East and Africa declined by 15.9% to USD 30.2 million in fiscal year 2020. Other Regions accounted for 1.4% of the group revenue. ELP and telecommunication products saw sales decrease. CMS registered growth. ELP revenue in Other Regions declined by 6.9% to USD 12.1 million. Higher sales in Middle East were offset by lower sales in Northern America and Africa. Telecommunication products revenue in Other Regions decreased by 23.5% to USD 16.6 million. The decline was attributable to sales decrease in Northern America, the Middle East and Africa. CMS revenue in Other Regions was USD 1.5 million in the fiscal year 2020 as compared to USD 1.2 million in the previous fiscal year. Thank you. I will now hand over to King for the outlook.

Thank you, Andy. Good afternoon, ladies and gentlemen. The COVID-19 outbreak has and continues to cause unprecedented disruptions around the world, creating uncertainty in our outlook for the financial year 2021. As we speak, the group's key markets are still in various states of lockdown. Demand has been impacted, resulting in lower orders. Consequently, revenues from all our businesses for the financial year 2021 are expected to decrease. To mitigate the resulting impact, we are strengthening cost control as well as focusing on cash and liquidity. We will streamline our operations and slow new capital expenditure. Inventory management is being tightened. Credit control and accounts receivable are closely monitored, especially for accounts with liquidity concerns. The outbreak has accelerated the shift to online purchases. To capture the immediate opportunities and better align ourselves to the long-term trend, we are strengthening our sales and marketing efforts on e-tailers and other online channels. And as always, for the future and to consolidate our market leadership, we will speed up product development and increase our pipeline of innovative products to the markets. Let's now take a closer look at our 3 businesses. First, ELPs. The group will focus on strengthening our market position through new product and expansion in Asia Pacific. In stand-alone products, new infant, toddler, and preschool products are being rolled out under the VTech and LeapFrog brands. Myla's Sparkling Friends, in addition to our offering in the robotics category for girls, will be launched in the U.S. in autumn 2020. It consists of a range of fantastical creatures the talk, sing and light up in different colors. The successful Kidi line will be augmented with KidiZoom Creator Cam, a high-definition video camera kit that offers editing capabilities for the young YouTubers. The LeapBuilders line will be joined by new SKUs featuring characters from the popular Blue's Clues & You!. In platform products, we introduced a new generation of KidiBuzz, which is being marketed in our European markets under the name KidiCom Max. In Asia Pacific, we are stepping up efforts to drive sales on online channels in Mainland China. And at the same time, we're increasing our penetration in Japan and Malaysia through channel expansion and broader product listings. Next, telecommunication products. The high-definition video baby monitors and super-long range residential cordless phones launched during the second half of the financial year 2020, will make a full financial year's revenue contribution. A new line of Voice-over-IP phones under the Snom brand will be rolled out, driving revenue growth in commercial telephones. And a newly designed series of hotel phones based on SIP and PSTN technologies will be introduced to regain market share. Anti-bacterial technology will be applied to our hotel phones and Snom branded business phones, enhancing their product appeal. A new baby monitor, employing cutting-edge technology and with an accompanying baby care app, will be launched to strengthen VTech's lead in the U.S. and Canada in this category. Finally, new IADs supporting the latest WiFi 6 standard will be shipped during the financial year 2021. CMS. As markets suffer the impacts of COVID-19 lockdown, we have seen customers revising their orders, thus resulting in demand uncertainties for our products. To create new avenues for our CMS business, a new product introduction center is expected to open in the second quarter of the financial year 2021 in the group's research and development center in Shenzhen, Mainland China. It aims to capture new businesses from the many startups in this technology hub. Further strengthening our strategy of production base rationalization, in December 2019, we signed an agreement to acquire a second manufacturing facility in Malaysia. It comprises over 0.5 million square feet of buildings in Penang. The new facility is expected to commence operation by the end of the financial year 2021. It will be used to manufacture ELPs and telecommunication products for the U.S. market. Meanwhile, our existing CMS facilities in Muar in Malaysia will be expanded in 2 phases, adding 50% of capacity upon completion. When all these come to fruition, our Malaysian manufacturing facilities will account for about 25% of group's total production capacity. Thank you. This completes our presentation. We now look forward to answering your questions.

[Operator Instructions] The first 2 questions come from Christina of HSBC. First, could you comment on online sales momentum for ELP and the contribution mix of the online sales in the U.S. and Europe? The second question is, could you also share more light on the recent raw material costs? Are they increasing due to shortage?

Thank you for the question, Christina. I will direct the first questions to King for the ELP sales online sales momentum.

Online sales, as we reported, has been increasing. And in Q4 of this past fiscal 2020, it's been especially helped because both of the brick-and-mortar stores are either being closed or are limited to essential goods. And this is especially true in the U.S., in China and in certain European countries, as I'm sure most of us know, there is at least 1 European country in which a major online retailer is still fighting the government to resume their normal business. And I think the second question is in regards to contribution of online business to our U.S. and Europe business.

So the second question is about raw material costs in our [indiscernible] raw material prices were decreasing. And even though after the outbreak of the COVID-19, we see the shortage, but in terms of pricing, we don't see there is any, say, material increase in prices, mainly because the overall demand of the components, especially for the raw material in electronic components, we don't see the demand is increasing, but just a short-term shortage, especially right after the outbreak of the COVID-19. So in the coming years, we don't think the raw material price will go back to an increasing trend.

Next one comes from Eric from Citi. Can you update how was the sales performance in the first quarter of the financial year 2021 on a year-on-year basis? How is the order visibility amid COVID-19 impacts for the financial year 2021? And which quarter will be the trough for the financial year 2021?

Okay. Thank you, Eric. I cannot disclose the exact sales figures. The sales performance for first quarter '21 is still ongoing until end of June. But so far, because of the lockdown of the COVID-19, the sales are down as compared to the same period last year. Now to your second question, the order visibility for fiscal '21 amid of the COVID-19, frankly, it's really hard to predict at this point when the COVID-19 will be over. So until that is known, it's really hard to predict what the order looks like. But one thing is for sure, the orders for this coming fiscal year will definitely be lower. I think as to how much lower, we really don't know for sure. And your question is which quarter will be the lowest for fiscal '21. We hope the first quarter will be lowest provided if the lockdown will gradually be released in the second quarter and third quarter onwards. But until that happens, I cannot say for sure.

The next questions come from Integra Capital. How will the trend towards work from home impacts the telephony business? How are we positioning the business?

The work from home has actually had some positive impact to our telephone business. In fact, not only the telephone business, in fact, it also benefits the ELP business as well as people now stay more at home, they are actually buying more of the toy products. And for telephone products, we have a whole line of telephone products cater for home offices. And we are seeing positive sales result mainly through online on those products. And your second question is how are we positioning the business. The telephone business is mainly divided into 2 main areas. One is residential phones. We are about half of our telephone business, and the residential phone business is on a structural decline. On the previous financial year, we actually had been doing quite well, although we still see some decline in the residential phone business, but we have gained market share in the U.S., and hence, the decline in our residential phone was actually slower than the overall residential phone decline. As far as the new businesses, which consists of approximately another half of our telephone business, certain sector has been doing well. We have been launching new products in a number of areas. [ This norm ], we have been launching new products, and we are seeing positive results. On the baby monitor, in particular, the new line of products we have launched last year has been received positively, so we are seeing also positive sales results. And also on the CAT-iq handsets, these are also doing well. So we believe that, again, for -- if you ask me for prediction, for this year, what will be the sale performance, I frankly cannot say in the middle of the COVID-19 crisis. But the restructuring of the telephone business is generally positive. And I can safely say that, although we may still see decline for this sector in this fiscal year, but I hope it will be slower.

Thank you, Mr. Wong. The next one is from [ Carlton ] from Daiwa Capital Markets. He has 3 questions. First one, our cash position remained strong at year-end. Why was the dividend payout ratio reduced? What will need to be seen for the payout ratio to return to near 100%? His second question is what is the order visibility now? Roughly, how much orders have declined in April and May? His third question is, how much revenues are we doing in China? Will we consider adopting new retail methods such as live streaming to boost online sales?

Let me answer the first and second questions. It's true that our cash position is still strong at year-end. However, the outlook is really very uncertain. I can tell you that the uncertainty we are facing is in my 45 years in business is probably I've never seen anything like this. So as a responsible management, we would like to conserve a little more cash in the company just in case we have some really rough time going forward. And also, we may also see some good opportunities for expansion also. So we are reducing the dividend payout from 99% last year to 70%, again, just as a conservative measure. We believe that once we have seen more visibility going forward, that is, the COVID-19 crisis is over or we have seen some vaccines underway, then we are in a much better position to say when we are able to go back to paying out all our earnings. As to the order visibility now, as I said in my earlier questions, it's really hard to say. I really don't have any certainty in order visibility. The second question, how much orders have declined in April and May, I cannot disclose exact figures, but we certainly have seen a significant decrease in orders. So the third question, I would give it to King to answer China.

We normally don't break out a specific country, but I think we have also shared in the past, our China revenue is about -- it's a little below 5% of total group revenue. And I think there was a question about, are we doing live streaming, the answer is yes. We are doing live streaming on our Tmall flagship store. We are working with distributors who have a lineup of KOLs who are doing live streaming to sell our products on their live streaming channel. So it's a booming channel for online, e-commerce in China, and we're taking full advantage of it.

The next question is from [ Luis Kim ], [ GCIS Limited ]. How are ELP sales in China in April '20 compared to April 2019?

King?