Realtek Semiconductor Corp

TWSE:2379

Earnings Call Transcript 2023-Q1

[Operator]

Good afternoon, everyone. Welcome to Realtek's 2023 First Quarter Earnings Call. This call is be chaired by Realtek's spokesperson Yee-Wei Huang. The presentation will be available on the company website before 6:00 p.m. today.

At the beginning, our spokesperson will report our first quarter results and give a management's remarks. After that, we will have a Q&A session. [Operator Instructions] During the call, you can browse through the pages of the presentation anytime.

Note that, portions of what presented in this call contain forward-looking statements. Investors are cautioned that forward-looking statements involve risks and uncertainty. Actual results may differ materially from the results forecasted or implied in such statements. Investors should not place undue reliance on such statements.

Now I'll pass this call to our spokesperson Yee-Wei.

[Yee-Wei Huang, executive]

Thank you. Good afternoon, ladies and gentlemen on the line. You are currently participating in the first quarter 2023 webcast earnings release hosted by Realtek Semiconductor Corporation.

Now let us go through the first quarter 2023 operational results. Q1 revenue was TWD 19.63 billion, a 9.8% Q-o-Q drop, and a 34% decline compared to the same period in 2022. We believe Q1 is the trial of the current cycle. We expect second quarter to be better than the first, and the second half better than the first half as far as we can see now.

Q1 gross margin was 43.1%, a 0.6 percentage point drop compared to the previous quarter. Main factors leading to the drop include; one, product mix change; 2, high average cost; 3, ESG pressure from competitions as well as customers; and 4, accounting loss from slow-moving inventory. These factors are expected to stay in the short term. Nevertheless, we believe that the mid to long-term growth profit margin may still be better than that before COVID-19.

Q1 operating expense was TWD 7.05 billion, or 35.9% of revenue. OpEx drops Q-o-Q, but OpEx ratio creeps up a little due to a lower quarterly revenue. Assuming the revenue were improve in the second quarter and in the second half of the forecast, we expect the OpEx ratio to stay at roughly the same level as that in 2022.

Operating profit in Q1 was TWD 1.42 billion, or 7.2% of revenue. Lower revenue and gross margin and higher OpEx ratio led to the sliding of operating profit ratio. Q1 non-op income was TWD 454 million, which is about the same as the last quarter. Q1 net profit was TWD 1.79 billion, or 9.1% of revenue. Q1 EPS as a result was TWD 3.5.

Regarding inventory, Q1 inventory turnover days were at 210 days, a 6-day increase from the 204 days last quarter. The increase in turnover days is a result of a lower revenue run rate. In terms of dollar amount, Q1 inventory decreased by 17% compared to the last quarter. We also have first quarter '23 balance sheet and cash flow statement for your reference at your convenience. This concludes Realtek first quarter financial reports.

For the second quarter in the near-term, with the improvement of the downstream inventory situation and the stabilization of demand in some markets, the second quarter operation looks prudently steady. Nevertheless, the overall market visibility is limited. We have to watch closely the impact of global economic changes on the end demand.

Now let's review the top product lines at Realtek. Before that, we observed that PC versus non-PC revenue split was approximately at 29 to 71 in the first quarter. 2 related factors contribute to achieve revenue for our PC-related products in the first quarter. First, PC-related shipment was held back a lot in fourth quarter last year to help Realtek customers and channels manage their inventory. And 2, PC rush orders seen in the first quarter.

Now on Ethernet overall, we are seeing customers resuming their orders and resourcing inventory in Q1. Ethernet revenues from the PC segment, especially for motherboards and consumer PCs, fare better than other segments in Q1. This is because Realtek held back Ethernet shipment more to PC customers than others in fourth quarter last year in concordance with the requests from the PC customers. Although, the market visibility is limited, we don't expect the Ethernet market to improve further in the second quarter with the preparation for the coming hot season in both PC and gaming markets.

The switch business remained anemic in the first quarter and won't see significant rebound in the second quarter because the demand is still weak due to geopolitical tensions between U.S. and China as well as that in Europe. Plus, the downstream is still in inventory digestion mode. However, Realtek still expects the market to gradually return later in 2023 and continue its recovery in 2024. We see mid to long-term growth in managed switch and multi-gig switches.

Now on Wi-Fi, similar to Ethernet, Wi-Fi business did better in PC and consumer segments in the first quarter with Wi-Fi IoT outperforming all other Wi-Fi applications. China markets seem to be quieter than that outside China. Despite a slow start and slow spec upgrade in other areas, Wi-Fi 6 penetration continues its strength in PC and router applications. Wi-Fi 6 is expected to reach up to 70% in PC applications in 2023.

For router, Wi-Fi 6 penetration may reach up to 60%, each up to 10 percentage points higher than the respective penetration in 2022.

For Realtek, Wi-Fi 6 revenue today accounts for about 30% of total Wi-Fi revenue. And we expect this will gradually, Wi-Fi 6 will gradually outgrow others in foreseeable future.

Wi-Fi 7 plus 5 continue as we speak and will go on until mid-year. It will be 2024, 2025, before we may see volume shipment of products using Wi-Fi 7 because of high price, complicated specs, and more. Now on Codec, Audio Codec, although PC market may have bottomed out as evidence by some rush order in Q1. The full year outlook remains conservative. In fact, many PC OEMs and ODMs seem to forecast a 10% drop in 2023 compared to 2022.

For first quarter, IDC reported a 29% year-over-year drop of PC shipments, including desktops, net notebooks, chrome books, and Apple. This implies a continuing recovery in the second quarter is expected. Realtek expects a notable Audio Codec Q-on-Q growth in second quarter.

For non-PC applications, we continue to see growth opportunity for Audio Codec in gaming-related areas. For TV, along with other consumer applications, Realtek TV SoC saw rush order coming in Q1. The main reason, though, appears to be a reaction to the AP buttoning out for PTV panels and DRAMs. Worldwide TV shipment is expected to be flattish in 2023 compared to last year. Realtek, nevertheless, may see a slight growth for our TV SoC shipment this year.

[Operator]

Thank you, Yee-Wei. Now we are entering the Q&A session. [Operator Instructions] The first question is from Randy, Credit Suisse. How are you seeing the product momentum by application for the second quarter? Are you seeing business recover across the board or are any areas still showing weakness?

[Yee-Wei Huang, executive]

Okay, we have seen order pull in, mainly in consumer segment and some in PC. To this end, we are cautiously optimistic about second quarter. Nevertheless, it will be premature to reach -- to read such pull-ins and short-term optimism as a sign of full market recovery. We have to pay close attention to the increasing challenges come from a few directions, price pressure from customers and competition, limited market visibility, and slower-than-expected spec upgrades.

[Operator]

The second question is from Daniel, Morgan Stanley. What's the gross margin outlook recently? Will second quarter gross margin continue to subject to inventory write-off?

[Yee-Wei Huang, executive]

Well, the short-term pressure on gross margin is still high on all fronts that will impact second quarter gross margin, pressure includes product mix, ASP pressure from competitions and customers, ASP and also ASP staying at high point at foundry suppliers. And of course, yes, slow-moving inventory write-off on selected products.

[Operator]

Next question is from Chen, Zhang. Will you anticipate the first quarter '23 revenue be the trial of the year? And will also the gross margin be the trial of the year in the first quarter '23?

[Yee-Wei Huang, executive]

Well, as we mentioned, all the pressure on gross margin still exists. But then on the other hand, we also expect second quarter to grow steadily. So the tool, this action, they actually counteract each other. So I wouldn't be able to tell you with certainty where we will land on gross margin in the second quarter.

[Operator]

Thank you, Yee-Wei. A follow-up question regarding the profitability. Bruce, Goldman Sachs, would like to ask what's your expectation on profitability for the first half '23 and second half '23? And what's your expectation for a reasonable long-term profitability and gross margin level?

[Yee-Wei Huang, executive]

We still plan for a better second half than the first, both in terms of revenue and gross margin, provided that the forecast for strong second half this year holds. Nevertheless, we have to reiterate that the visibility for the second half is very murky at the present time.

For long-term, we still try to follow a gross margin around the high end of our historic range before COVID-19, if not higher.

[Operator]

Next question is from Sunny, UBS, regarding OpEx ratio. What is your target on the R&D expense and OpEx ratio in amount for 2023? And what's the reasonable OpEx ratio going forward?

[Yee-Wei Huang, executive]

Okay. For 2023, we plan for roughly the same level of R&D expense and OpEx ratio as those of 2022. In the long run, lowering our OpEx ratio a few percentage points less than the current level is still our goal that we believe to be achievable.

[Operator]

Next question is from William, JPMorgan. What is the market and order visibility for 3 major applications, such as consumer, PC, and networking? How strong is the rebound in second half '23?

[Yee-Wei Huang, executive]

We are seeing rush orders as we speak. These orders are almost all of the nature of order pulling in. And the majority of them come from the consumer segment and some from PC related. Most, if not all, of our customers in all segments express limited visibility for the second half. For planning purpose, nevertheless, overall still plan for a notable better second half than the first. We expect it's planning the same. We're likely to know better toward the end of second quarter.

[Operator]

Next question is from [indiscernible], Daiwa. Are we still maintaining our 2023 revenue guidance to flat 2022?

[Yee-Wei Huang, executive]

We do not really give guidance per se, at least not quantitatively. But we will say, no. All the goals we set, we will try. But today, we don’t see the challenge by the end of the first quarter. The challenge we see is more severe than we started the year. So we will work on one quarter at a time and come back to this towards the end of the quarter.

[Operator]

Thank you, Yee-Wei. Next question is from Rick, Daiwa. His question is about inventory. How's inventory situation of Realtek's own inventory as well as customers and distributors now?

[Yee-Wei Huang, executive]

Okay. So, well, after focusing efforts in fourth quarter 2022 to help Realtek customers and channels manage their inventory, we are seeing inventories outside Realtek reasonable in most cases. In fourth quarter, we see in-house inventory in terms of absolute dollar amount decreasing in spite of an increase in inventory turnover days. Moving forward, we will adjust new wafer start dynamically by taking all factors into consideration, including market demand, wafer price, and potential -- particular wafer supply constraint.

[Operator]

Next question is still regarding inventory. Randy, Credit Suisse, question is, how do you see your inventory trending down in the coming quarters? And when do you expect to get back towards 100 days or lower if that is still your target?

[Yee-Wei Huang, executive]

As we just explained, due to the dynamic nature of the market we are living in today, moving forward, we will have to take all factors into consideration before we decide a new wafer stock each month. To this end, setting less than 100 days may not be an optimal goal as we try to optimize our business operation.

[Operator]

The next question is from Lucas, KGI. What's our foundry supply status in 2023? Which quarter will we start to increase wafer order placement in 2023? And when will foundry costs start to decline in our view?

[Yee-Wei Huang, executive]

Okay. As far as we know, most, if not all, foundry fabs are not running at full capacity at the present time. Many of them, nevertheless, are seeing the utilization to pick up in the second half and even more so in 2024. While all these may change, one thing seems to be certain is that there is no new wafer capacity expansion in 2023. To this end, Realtek is working with our foundry partners to do planned wafer stocks beyond the original plan. We are not in a position to comment on wafer foundry costs. So far as I can say, nevertheless, the rising interest rate and energy costs are not conducive to a cost reduction for the semiconductor industry.

[Operator]

Next question is from Jason, CLSA. Regarding PC demand, can you update on the demand or sales outlook and current inventory for your PC notebook product line?

[Yee-Wei Huang, executive]

The latest IDC forecast says that PC notebook market will decline 10.7% year-over-year to about 260.8 million units in 2023. This is a view more conservative than what was 3 months ago, but shared by many OEM and ODM PC makers.

The inventory level for Realtek PC customers in the first quarter is generally improving after our focused efforts to help their inventory management in the fourth quarter. As evidence, some PC customers are placing orders to rebuild their inventory.

[Operator]

Next question is on Audio Codec by UBS, Sunny. Could you also talk about the competitive landscape and technology upgrade in the Audio Codec?

[Yee-Wei Huang, executive]

Maybe SoundWire introduced almost 10 years ago in 2014 was intended to replace HDA and I2S in PCs and embedded systems. It is gaining traction, nevertheless, slowly but surely. Besides being a leader in HDA codec, Realtek SoundWire solutions are found in most PC reference designs as a frontrunner. TI and Cirrus Logic are also players in SoundWire solutions.

[Operator]

Next question is on telco project from Randy, Credit Suisse. How is the project activity expected to pick up into the coming quarter and continuing through second half both for China and overseas?

[Yee-Wei Huang, executive]

Global telco market appears to maintain a minimal level of activity in the first quarter, likely owing to geographical tension between U.S. and China as well as that in Europe.

Realtek still expects the market to gradually return later in 2023 and continue its recovery in 2024 as the need for continuing network infrastructure expansion remains. And infrastructure expansion is a tool, which governments of all regions often use to stimulate their economic growth.

[Operator]

Thank you, Yee-Wei. Next question is from Jason, CLSA. How is the Wi-Fi 6 and 6E penetration rate for different applications such as PC, notebook, router, TV and consumer devices?

[Yee-Wei Huang, executive]

We have seen the trend of Wi-Fi 6 penetration continues. It may reach up to 70% for PC, notebook and up to 60% for routers by the end of 2023. For TV and other consumer devices, the adoption of Wi-Fi 6 is rather limited. Overall, there seems to be less than 5% TV that are installed with Wi-Fi 6 today.

The penetration rate may go up a couple of percentage points by the end of the year as far as we can see. Wi-Fi 5 is the mainstream Wi-Fi solution for TV or consumer applications in general. The adoption of Wi-Fi 6E seems to be marginal as not all countries have approved the 6 gigahertz band for Wi-Fi.

For those applications that may need the cleaner 6 gigahertz spectrum, many, if not all will do it with Wi-Fi 7, which supports the 6 gigahertz band plus many other desirable features.

[Operator]

Next question is from Marco V. from MLT. Could you comment on the Wi-Fi competition in China such as HiSilicon and others?

[Yee-Wei Huang, executive]

We do run into China indigenous Wi-Fi solution supplier. Up to now, they still seem to be more on either Wi-Fi 4 or Wi-Fi 5. We have not really seen much, if any, really at the present time very active in Wi-Fi 6 and will continue to monitor the situation.

[Operator]

Next question is from Daniel, Morgan Stanley. What's the current Wi-Fi ASP allocation for each generation? What is the current Wi-Fi 7 progress?

[Yee-Wei Huang, executive]

Okay. The ASP ratio among Wi-Fi 4, 5 and 6 is roughly 1 to 2.5 to 4.4 by the end of first quarter. It was 1 to 3 to 4.5 a quarter ago. Clearly, the ASP of Wi-Fi 5 and 6 are dropping relative to Wi-Fi 4. For Wi-Fi 7, Realtek is actively involved in the process and supporting customers' design needs at the same time. Due to the high price, probably at about 10x relative to Wi-Fi 4. This is the fourth wave of Wi-Fi 7 products are aiming at high-end routers -- excuse me, high-end routers and mass production is not expected until 2024.

[Operator]

The next question is from Sunny, UBS. What are the drivers to managed switches and 2.5G Ethernet? For switches, what's the split of managed switch versus unmanaged switch last year? And how meaningful would you expect managed switch to account for in 2 to 3 years? What's the latest progress of your share gain in managed switches?

[Yee-Wei Huang, executive]

Well, a common theme behind managed switch and 2.5-gig for that matter, multi-gig Ethernet is the enhancement in feature and performance, which is a growth driver for both Ethernet and switch business for Realtek in the coming 2 to 3 years, despite the market is still facing short-term headwinds. 2.5 gig Ethernet today is mainly used in high-end PCs, motherboards, some gaming PCs, and peripherals such as docking stations and dongles in PC and monitor applications.

In addition, there is also demand for 2.5 gig and multi-gig Ethernet in routers and broadband equipment. We expect to see a steady increase of penetration once the market demand recovers. Realtek's multi-gig Ethernet solutions are superior to competitors in terms of power consumption, interoperability, and cost-performance ratio.

The market demand for managed switch has been far bigger than that for our managed switch. Triggered by the needs in post-pandemic and 5G technology trends, we are seeing increasing demand for higher speed and more manageability. Realtek continues to develop new generation Ethernet and switch products to enlarge our market share step-by-step.

[Operator]

Next question is also Ethernet related from Kevin, Mizuho. Can Realtek provide recent updates on current sales contributions from automotive Ethernet IC? And what is the current penetration rate of Ethernet IC in automotive and market share? And what is the sales contribution target for this product line in 2024 through 2025? Other than Ethernet IC, do you plan to offer other ICs in the automotive application?

[Yee-Wei Huang, executive]

We do not comment on revenue contribution by a single product line, nor do we comment on market share. Suffice to say, nevertheless, Realtek's automotive Ethernet product line continues to make strides in the automotive market, growing at an above-average growth rate. The growth momentum is expected to continue into 2024-2025. Overall, about 50% of the new cars today have at least Level 1 autonomous driving, which almost guarantees the adoption of automotive Ethernet.

The automotive Ethernet market is served by a small number of Ethernet veterans such as Broadcom and Mobile, besides Realtek. Every player is highly competitive. With the success of Ethernet 5 and switches, automotive OEMs and Tier 1s today recognize Realtek as a quality automotive silicon solution provider. They are inviting Realtek to discuss with them silicon solutions for cars in addition to Ethernet. We will disclose our progress and achievements to you at an appropriate time. In the mid to long-term, revenue related to the automotive market will play an increasingly important role in Realtek's growth.

[Operator]

Next question is regarding consumer market from Randy, Credit Suites. Do you see TV and consumer applications continuing to improve? Will there be a margin impact from mixed shift back towards consumer?

[Yee-Wei Huang, executive]

While Realtek's presence in the consumer market, including TV, has a long history with a safe-up foothold. This segment seems to be doing better than others in Q1. In short term, the product mix will impact the corporate gross margin Nevertheless, we expect the business will gradually recover and the spec upgrade will continue in all segments we plays-in, including PC, network communications, and automotive.

Forward-looking, we have our eyes on healthcare and industrial segments. Based on all above, we do expect there will be headroom for gross margin to improve in the long run.

[Operator]

Thank you, Yee-Wei. Next question is from Lucas, KGI. He would like to know demand outlook for the TWS products in 2023-2024. What is the company's view about the competitive landscape within the TWS market? And what is the Realtek's advantage compared to its peers in the TWS area? Do we see greater pricing competition from our peers?

[Yee-Wei Huang, executive]

Okay. Realtek has gradually exited pure price competition segment since the beginning of the supply shortage in 2020. The price competition in this segment is ruthless to say the least. However, we continue to invest in BT SoC solutions, aiming at high-end, high-value TWS applications, such as the one with hearing assist features, as well as wearable's supporting audio voice features.

Further, Realtek has a complete Bluetooth product line, including BT NIC and BLE SoCs that address a wide array of applications, such as electronic shelf labels, remote controller, and wearables that require efficient, short-range, low-power wireless connectivity. Bluetooth will remain a focus wireless connectivity product line in Realtek.

[Operator]

Next question is from Sunny, UBS. Can you talk about the ProRes roadmap in the USB4 and the PCIE 5? Presumably, your focus is on the host end.

[Yee-Wei Huang, executive]

Well, Realtek's first USB4 product, which is a full-featured USB4 hub controller, is at customer site for testing. It is scheduled to reach production by year-end. Our first PCIE 5 SSD controller is on schedule to come out in the second half of this year.

[Operator]

Next question is from Sunny, UBS. Regarding competition, with the demand correction and inventory digestion, are you seeing increasing competition? Does any specific product line see more pricing pressure?

[Yee-Wei Huang, executive]

Well, there is never a shortage of competition at any time. While the global economy is weak and inventory challenges still exist in various parts of the industry, they do aggravate the price pressure. We have to cautiously adjust our business and procurement strategy to fare well against the fierce competition.

[Operator]

Next question is from Lucas, KGI. He would like to know the R&D headcount and what's our ideal R&D headcount in 2023 and how would it impact the R&D expense in 2023?

[Yee-Wei Huang, executive]

Well, we see 2023 not a strong growth year in terms of top-line revenue. While we intend to keep R&D expense and operating expense ratio to about the same level as those in 2022. To this end, we do not envision a big change in our R&D headcount. Note, nonetheless, we will not stop scouting for talent and recruit them and bring them in when we find them.

[Operator]

Next question is from Daniel, Morgan Stanley. Does Realtek have any new product technology that is likely to be the mid-to long-term growth driver?

[Yee-Wei Huang, executive]

Realtek continues to focus on various technology solutions that enable ubiquitous connectivity among machines and between machines and humans. Such solutions often complement 5G networks that provide a wide area network infrastructure. While Realtek solutions offer local and personal area networks completed with an audio-video-based most natural man-machine interface.

To this end, Realtek sees 2 enabling technologies that may fuel future growth for the company. One, optical-based network communication technologies; and 2, AI-based audio-video solutions. We plan to have products embedding these technologies in time and will share the progress in due time. Besides, on top of the markets we serve today, we target to expand markets into auto, healthcare, industrial segments, which will support the long-term growth of the company as well.

[Operator]

The next question is from [indiscernible]. He would like to know, you mentioned the slower spec upgrade than expected. Which products are impacted?

[Yee-Wei Huang, executive]

We did mention Wi-Fi seems to defy the spec upgrade slowness. That implies that, other than Wi-Fi, for example, the 2.5 gig Ethernet, as an example, that's being affected.

[Operator]

Due to time constraints, we will conclude the meeting now. Thanks for your participation today. Please feel free to contact our IR team, if you have further questions after the meeting. The reply will be available on the IR page of the company website before 6 p.m. Thank you, and have a good afternoon.