Realtek Semiconductor Corp

TWSE:2379

Earnings Call Transcript 2023-Q2

[Operator]

Good afternoon, everyone. Welcome to Realtek's 2023 Second Quarter Earnings Call. This call is charged by Realtek spokesman, Yu Yen Kuang. The presentation will be available on the company website before 6:00 p.m. today. At the beginning, our spokesman will report our second quarter results and give a management's remark. After that, we will have a Q&A session. [Operator Instructions]Note that portions of what's present in this call contain forward-looking statements. Investors are cautioned that forward-looking statements involve risks and uncertainties. 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 will pass the call to our spokesman, Yu Yen.

[Kuang Yu Yen, executive]

Okay. Thank you. Good afternoon, ladies and gentlemen, on the line. You are currently participating in the second quarter 2023 webcast earnings release hosted by Realtek Semiconductor Corporation.Now let us go through the second quarter operation results. Q2 revenue was TWD 26.29 billion, a 34% Q-o-Q increase, but a 13.8% decline compared to the same period in 2022. Q2 showed a visible growth after the bottoming out in the first quarter. The main reason behind the growth is the restocking of PCs and consumer electronic goods.Q2 gross margin was 41.7%, a 1.4 percentage point drop compared to the previous quarter. Main factors leading to the drop include product mix change, ASP pressure from competitors as well as customers, and accounting loss from slow-moving inventory.Q2 operating expense was TWD 8.87 billion or 33.8% of revenue. OpEx ratio dropped 2.1 percentage points, thus meeting expectation. Q2 operating profit was TWD 2.09 billion or 8% of revenue. Higher revenue and lower OpEx ratio led to a climb of operating margin. Q2 non-op income was TWD 627 million, an increase from last quarter, thanks to higher interest income and foreign exchange gains.Q2 net profit was TWD 26.1 billion or 9.9% of revenue, a 0.8 percentage point increase quarter-over-quarter. So net, Q2 EPS was TWD 5.08.Regarding inventory, Q2 inventory turnover days were at 133 days, a noticeable decrease from the 210 days last quarter. In terms of dollar amount, Q2 inventory decreased by 13% compared to the last quarter. We expect inventory base to continue to fall in the third quarter.We also have second quarter balance sheet and cash flow statement for your reference and your convenience. This concludes real time second quarter financial reports. For third quarter, the global economy remains unpredictable. Although the end market demand is recovering, the order visibility is limited. We maintain cautious about the third quarter operations.Now let's review the top product lines at Realtek. First, we estimate that PC versus non-PC revenue to be approximately at 32% to 68% in the second quarter. This represents the second consecutive quarter for sales [indiscernible] [ for ] PC-related product at Realtek. This speaks to the restocking of the PC market and the slower than expected recovery of other markets, communication network in particular.Now on Ethernet for PC market. As the inventory problem on the customer side abated, Ethernet orders showed a substantial growth in the second quarter, including some pull-in of third quarter order so that product can go by sea to save transportation costs.Nevertheless, the overall PC market is softer than expected, resulting in [ stagnant ] adoption of 2.5 gigabit per second Ethernet. Still, we see the market need for faster Ethernet, a sure trend as faster connectivity is essential to mass-enable AI applications.In second quarter, we have customers starting engineering field of PC motherboard featuring 5 gigabit per second Ethernet. Outside of PC domain, the Ethernet demand for CE and network remained slow in second quarter. For long term, multi-gig solutions will drive the growth of Ethernet business for both PC and non-PC applications.Now such business is -- has a strong correlation with the strength of the global communication network infrastructure buildup, which in general remained weak in the second quarter. The best we can see, the weakness may continue in third quarter for -- it will be fourth quarter before shipment can start for telecom tender projects awarded in the third quarter.Most believe the telecom tender project where we gain its strength in 2024. When the strength returns, multi-gate switches with 2.5 gig or 10 gig or 10 gig, [ 5 ], will be in high demand to match the performance of 10G PON and Wi-Fi 7. Although Realtek is not in the extreme high bandwidth switch segment for data centers and AI servers, our managed switch solutions with increasing performance and manageability in [ APO ], indispensable mass connectivity between Edge AI devices and the cloud servers.Now we look at the Wi-Fi, which you see growth in both consumer and PC segments. For consumers, orders were pulled in, in second quarter to anticipate a strong [ 618 ] sales that did not happen. For PC Notebook, orders were placed in second quarter to ensure a healthy inventory by several customers, despite a mediocre PC market.Wi-Fi in the network market was slow consistent with what was seen for switch. Wi-Fi 6 remains the preferred [ fact ] in many consumer-oriented and PC applications. Wi-Fi 6 penetration may reach 70% for PC and 60% for routers by year-end. Wi-Fi 7 [indiscernible] is still ongoing as we speak. We'll have first Wi-Fi 7 [ will ] target as high-end routers and PCs.Now on core debt. Although we saw PC-related rush order in second quarter, the 2023 full year PC forecast remains soft by fourth quarter and the consensus appeared to be a 10% year-over-year drop in total PC notebook, Chromebook shipment in 2023. The new consensus seems to be -- seems to suggest a 15% drop year-over-year to around 250 million PC Notebook, Chromebook in 2023, followed by a very mild, maybe 3% growth in 2024.Outside PC we'll continue -- Outside PC, we will have consumer Audio Codec continue to find success in gaming and mobile phone market. Further, we will have Audio Codec with AI noise suppression, is [ finding ] its way into automotive applications.Last, but not the least, TV experienced stronger-than-normal orders in the second quarter, mainly due to an anticipation of rising panel price. Overall, most expect the TV market to end around [ TWD 195 million ] to [ TWD 200 million ] for full year 2023, flattish to a small gain compared to 2022. By region, China, Southeast Asia and Europe are slow, while U.S. and India fare better. [ We have ] TV is staying the course to beat the market performance through share gain.

[Operator]

Thank you, Yu Yen. Now we are entering the Q&A session. [Operator Instructions] The first question is from Randy, Credit Suisse. How much do you expect to grow in the third quarter, and fourth quarter affecting your second quarter saw a strong recovery already? Which application do you expect to lead the growth? And do you see any area now correcting?

[Kuang Yu Yen, executive]

Well, after a notable second quarter, 32% -- 34% Q-o-Q gain, although the global economy remains unpredictable and the order visibility is limited, we still expect a better second half compared with first half. We expect most market segments to check along at a similar pace that they experienced in second quarter.No one is expecting any growth spurt in any particular segment for the rest of the year. The wildcard may be the global telco tender projects, both in China, in particular. A strong telco tender market in second half may help Realtek full year performance.

[Operator]

The second question is from Daniel, Morgan Stanley. Is there any preliminary outlook for 2024 that you can share?

[Kuang Yu Yen, executive]

Yes. Every customer we talk to is expecting the business to return to growth in 2024. We share the conviction. The question is when in 2024 do we see the turnaround. An important note is that the fundamental for demanding better AI, big data, autonomous driving, electric cars, Internet of everything, demanding a smarter or better connected world. This fundamental has not changed.If anything, the demand is becoming stronger than ever. The connectivity solutions offered by Realtek from PON to switch, from Ethernet to Wi-Fi, from USB to Bluetooth, from audio to video, are critical to mass-enable numerous Edge devices with most natural man-machine interface to work in concert with and complement the AI data server in the cloud.The late half 2024 and beyond will bring enormous opportunities to Realtek.

[Operator]

Next question is from Sunny Lin, UBS. How should we think about the structural gross margin versus pre-COVID label? From fully perspective, in which quarter would you expect the gross margin to stabilize with inventory write-down impact moderating?

[Kuang Yu Yen, executive]

Yes. Indeed, one major factor depressing, we'll have gross margin since second half of 2022, is the accounting loss from slow-moving inventory. Although this factor has been impacting Realtek gross margin since second half 2022 due to the fear of supply shortage and through order visibility, compounded by uncertain global economy. Well, in fact, it's expected to subside after the third quarter as we regain inventory control. In mid to long term, we still move forward a product mix with higher value and better gross margin.

[Operator]

Next question is from William, JPMorgan, regarding the inventory. Please update the inventory situation by your major product or inflow applications?

[Kuang Yu Yen, executive]

Well, the inventory of all product lines is moving in the right direction. For PC and consumer applications, we are seeing restocking on customer side. The communication network products are the ones whose inventory is still relatively high due to the weak market demand. Moving forward, Realtek will work closely with our suppliers and customers to ensure a healthy inventory in the supply chain.

[Operator]

Next question is from Randy, Credit Suisse. Can you discuss your expense growth in the second half or expected OpEx as a percentage of revenue, if the revenue growth slows down?

[Kuang Yu Yen, executive]

Well, controlling operating expenses is always at the top of the agenda for Realtek management. We have seen great revenue variations in the past 6 quarters from a quarterly high of TWD 30.5 billion to a quarterly low of TWD 19.6 billion. Nevertheless, our OpEx ratio fluctuated within a small interval between 33.8% and 35.9% in the same period.In the short term, it is most likely that the OpEx ratio would stay within the small interval seen in the past 6 quarters. In the long term, as the company scales up, we're still striving to lower our OpEx ratio.

[Operator]

The next question is from Kevin, Mizuho. What is the current order outlook for PC-related business in third quarter?

[Kuang Yu Yen, executive]

Yes, the order visibility is rather limited for PC-related business, or for that matter for all business as we speak. Regardless, due to a strong second quarter performance, we do not expect to see a traditional seasonal peak in third quarter this year for PC-related business. Nevertheless, we still expect a better second quarter -- second half than first half for our PC business.

[Operator]

Next question is about the PC outlook in 2024. Microsoft may launch Windows 12 in 2024. What's your initial assessments about the replacement opportunities and the PC demand next year?

[Kuang Yu Yen, executive]

Well, there's no set rule when it comes to PC refresh. Nevertheless, conventional wisdom seems to suggest a 3 to 5 year refresh cycle for PC Notebook. During COVID-19, about 300 million to 350 million PC Notebook was sold each year in 2020, 2021 and 2022. That is 50 million to 100 million more than the normal PC annual run rate.By 2024, some of those PCs are up for refresh. That may provide a more refresh opportunity than Window 12 release. Well, [ Chrome ], which nevertheless, may bring additional incentive for PC Notebook refresh. All PC market players are paying close attention to the development.

[Operator]

Next question is from Bruce, Goldman Sachs. Could you update us on the China tender market? How is the pace of the recovery in first half 2023? And have we seen any signs of stronger growth in the second half?

[Kuang Yu Yen, executive]

Yes. Telco tender project delay seems to be common in 2023 in China as well as elsewhere. We are tracking several tenders in China, Southeast Asia and even North America. Most believe the awards should come in the third quarter. Once announced, we may take another 3 to 5 months to reach a meaningful shipment. It is worth noting that the infrastructure built up is actively pursued by governments around the world.Case in point, U.S. has announced to spend $42 billion to make Internet assets universal by 2030. Such infrastructure expansion projects always provide growth opportunity to Realtek.

[Operator]

Next question is from [ Rick Daiwa ]. For [ exceeding ] products, are they facing pricing pressure? How much of price erosion for the [ exceeding ] product this year and any potential threat from the competition for [ Realtek ]?

[Kuang Yu Yen, executive]

We prefer not singling out particular competition in our comments. Price pressure is all in the base work in our industry. It comes from all directions, from suppliers, customers and competition. After a couple of years of price up, the pressure for price down is very real in 2023, especially when the market is slow. While we're receiving little pricing relief from suppliers, some customers are actually requesting the price to be back to the pre-COVID level, which is impractical and impossible.We are working with our customers and suppliers closely and discretely to seek win-win. Overall, we see the pricing to be under control. More importantly, we are developing quick solutions with better cost structure and more desirable features to justify our product value.

[Operator]

Next question is from Bruce, Goldman Sachs. Given the overall demand slowdown of the progress on [ spec ] migration, especially for Wi-Fi markets, is the migration on track or slower than we expected?

[Kuang Yu Yen, executive]

Spec upgrade for connectivity solutions never stops. Only question is how fast. When the market is slow, spec upgrades normally slow down as well. For Wi-Fi, the migration to Wi-Fi 6 continues. As previously highlighted, we estimate up to 70% of PCs and 60% of routers will go with Wi-Fi 6 or 6E by the year end.For Wi-Fi 7, there is a high level of interest in the field. Some anticipate the ramp-up of Wi-Fi 7 to be faster than that of any of its predecessors. Therefore, it's many invaluable features. Perhaps the most exciting one is [indiscernible] operation with several frequency across different [ banks ] are combined into a single connection. This provides a highly efficient use of the available frequency spectrum.To be practical, nevertheless, we believe a ramp of Wi-Fi 7 may start in 2024 at the earliest and the pace may be modest. Know that many countries, including China and most in Southeast Asia, Middle East and Africa still have not approved the 6 gigahertz span for Wi-Fi usage.

[Operator]

Next question is on Wi-Fi by Lucas, KGI. What are the anticipated penetration rates for Wi-Fi 6 and 6E and PC notebooks and routers in 2024? Is there any potential for accelerated penetration of Wi-Fi 6, 6E in other applications?

[Kuang Yu Yen, executive]

Well, the market is anticipating Wi-Fi 7, Wi-Fi 6, 6E in PC and routers may gain another 5% to 10% penetration at both before saturation. As a rule of thumb, Wi-Fi 6, 6E are suitable for application that demand high throughput, low latency and low mass connectivity.Nevertheless, we envision Wi-Fi 6, 6E may become the [ fact ] of choice for mainstream market in time, leaving Wi-Fi 4 for some basic IoT applications.

[Operator]

Next question is from Aaron, Nomura. What's the current market share of your auto Ethernet products? And what's your view on competition? Do you see it rising from China? What's your product road map? And how big is the [ can ]?

[Kuang Yu Yen, executive]

We do not comment on market share as a matter of principle. We are only a handful of automotive Ethernet solution providers. Besides Realtek, Marvell and Broadcom are the 2 other marquees in the field of automotive Ethernet, where China players buying for the socket -- while competitions are good, the key technology moving forward. To estimate a [ temp ] for automotive Ethernet we'll consider the following factors.One is total annual live vehicle sales, which is expected to be between TWD 80 million and TWD 90 million per year in the next few years. Then penetration rate of Ethernet in light vehicles. By the end of 2023, International Energy Agency projects some 40 million EVs will be sold this year, which represents 17% EV penetration.By 2030, the EV penetration could reach 35%. All EVs above automotive Ethernet to the best of our knowledge, while some petroleum cars, especially those with a one or higher level of autonomous driving for sure adopt automotive Ethernet. Overall, we observed more than half of the 2024-2025 car models come with automotive Ethernet.Then the number of Ethernet ports and switches in a car varies widely from less than 5 ports per car with no switch for the entry model to greater than 20 ports with 20 -- with 2 or more switches for the high-end models.In terms of product road map, we are developing solutions to address the industry's needs for higher bandwidth performance, lower power, lower latency, more versatile interface and higher safety and security.

[Operator]

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

[Kuang Yu Yen, executive]

Well, certainly. Well, Realtek continue to focus on various technology solutions that enable ubiquitous connectivity among machines, and between machines and humans. Such solutions often complement by the networks that provide a Wide Area Network infrastructure while Realtek solutions of a Local and Personal Area Network completely with the audio video-based most natural man-machine interface.To this end, Realtek sees technologies that may not enable the AI world through various product offerings while fueling future growth for the company. Examples may include optical-based network communication technology and AI-based solutions. We plan to have products embedding these technology in time and we'll share the progress in due time.Besides the market we serve today, we target to expand the market to auto, health care and industry segments. This will support the long-term growth of the company as well.

[Operator]

Our next question is from Rick Daiwa. Do we have any new AI related projects going on?

[Kuang Yu Yen, executive]

In fact, AI is pervasive in Realtek chip solutions. We have AI picture quality in TV SoC, AI noise suppression for automotive communication, AI QOS in Wi-Fi AP routers, AI USB camera, to name a few. Realtek continue to find additional Edge AI applications in our new products.For AI infrastructure, we are committed to invest in communication network products with higher performance to meet the segment's needs. Further, we are using tools and planning to develop more tools with built-in AI capability for both chip design and business analytics.

[Operator]

Next question is from Sunny, UBS. What are the drivers for managed switches and 2.5 gig Ethernet? For switches, what's the weight of demand switches versus how many switches last year? And how manifold would you expect the net switches to account for in 2 to 3 years? What's the latest progress of your share gain in managed switches?

[Kuang Yu Yen, executive]

Well, again, AI, ChatGPT, big data, smart devices, autonomous vehicles, Internet of Things, cloud service, et cetera, all have one thing in common, they require ubiquitous connectivity. None of them could exist without network activity. 10G PON, Wi-Fi 7 are 2 examples of enabling technology to facilitate high-speed network connectivity.Working in tandem multi-gig switches equipped with 2.5 gig Ethernet ports. Managed switch that users adjust each port on the switch for any setting enabling them to be manage -- to manage, configure and monitor the network in many ways. They also provide greater control over how data travels over the network and who can access that data.Managed switches normally require a skilled administrator or engineer to make the most of their features. The growth drivers for managed switches include both the increasing demand by the enterprise and business operations and by IoT devices in a smart home network. Realtek today shipped many more managed switch and managed switch. We are seeing nonetheless managed switch to deliver higher growth both in quantity and revenue than managed switch as we speak and we expect this trend to continue.

[Operator]

Next question is regarding our Bluetooth business, from Lucas, KGI. What is the outlook for Bluetooth segments in 2023 and '24 and in the longer term? What growth opportunities are foreseen in the Bluetooth segment in the coming years? Can management share some details about the new Bluetooth products scheduled for the near-term launch?

[Kuang Yu Yen, executive]

Well, actually, Realtek Bluetooth solution find application in TWS, wearables, remote controllers, set-top boxes, electronic shelf labels and many more. We expect steady growth of Realtek Bluetooth products this year and 2024, led by new products that are optimized for wearables and [ BLE ] audio on [ one half ].

[Operator]

Next question is from Jason, CLSA. Hearing that TWS demand is improving, does Realtek benefit from this recovery?

[Kuang Yu Yen, executive]

Well, TWS market with the highest shipment volume still competes based on price and price only. Realtek has not competed in this segment since the supply shortage started in 2021. We focus on high-end TWS, including recently a derivative product [ featuring ] BLE audio and AI noise reduction that is tailored for the 1.5 billion people with mild to moderate hearing loss.

[Operator]

Next question is from Randy, Credit Suisse. Could you share or discuss how Realtek's position versus an overseas competitor series logic, which claims potential to gain share as audio codec supporting some wire are adopted? Does the standard change also have any meaningful dollar content increase or ability to drive more growth for the audio codec segment?

[Kuang Yu Yen, executive]

Yes, the new spec commands a higher ASP, which helped the top line growth. And Realtek, we not only -- for the longest time, is a leader in HDA codec. Realtek's wire solution is already found in most PC reference design as a front runner where we acknowledge AGI series logic. There are also players in some wire. But Realtek, we are confident to hold on to our audio codec supremacy in some wire codec.

[Operator]

Next question is still from Randy, Credit Suisse. Can you update on Realtek's offering for health and medical segments? What is the potential for this area to supplement auto and become a growth driver? Or is the segment too small relative to consumer or IT segment?

[Kuang Yu Yen, executive]

Realtek is moving steadily into the health, wellness market. Our Wi-Fi, Bluetooth, [ IG cam ], monitor scale solutions in different stages of entering health wellness market. A recent example is the [ OTG ] hearing aid, TWS, for mild to moderate hearing loss. The total market opportunities are not small by any measure.

[Operator]

Next question is from Daniel, Morgan Stanley. How the current pricing for TV SoC and your view on the trend for 2023 onwards?

[Kuang Yu Yen, executive]

Yes, short-term price pressure aside, most Realtek products are seeing ASP increase from one generation to the next. As customers demand higher spend and more integration, we see no exception for TV SoC in this case.

[Operator]

Next question is from Tiffany Yen, from Morgan Stanley too. Could you provide a breakdown ASP of Wi-Fi 4, 5, 6 and 7?

[Kuang Yu Yen, executive]

Yes. Roughly, what we see in second quarter, the ratio comes to about 1% to 3% to 4.5% to 8%. So what you are seeing is prices [ get ] -- shrink a little bit.

[Operator]

There's a couple of questions from Capital Investments. First, could you clarify the impact of inventory provision on second quarter 2023 gross margin?

[Kuang Yu Yen, executive]

It is a visible impact there, so we will -- let me say with that, the impact of this inventory provision on the second quarter margin is quite visible.

[Operator]

The second question is, could you update the Chinese Telco in [indiscernible], for example the set top box, the routers and the PON?.

[Kuang Yu Yen, executive]

Well, briefly, it's slow. And also you mentioned about OTG box. In China, you may hear roughly [ TWD 70 million ], as you mentioned. But when we look into it the actual deployment may be only [ TWD 50 million ] or lower. So that's the difficult part to really -- to get a hold of what really happened there.Sometimes you may hear the number -- for example, PON, they still talk about full year. There may be a total bidding volume maybe still around TWD 100 million. But if you look deep into it, the actual deployment will be much, much smaller than that and same for the router.

[Operator]

The next question is from Ethan Yang, TransGlobe Life. During the first quarter earnings, the management commented reducing the inventory to reach certain level is not the only goal to achieve. Could you update the directions of Realtek's inventory in terms of the amount and turnover days?

[Kuang Yu Yen, executive]

Right. The market visibility is low, uncertainty is high and everybody still -- sometimes they lose it when they recall the product shortage, the nightmare they had before. So often time, many factors come into play in inventory. At Realtek, we would like to work together not to shoulder all the burden by ourselves. So we're working very closely with our suppliers and customers to manage this.Now I -- clearly, I think the first goal is still looking at maybe less than 100 days -- turnover days -- to be 100, maybe not a hard and fast goal, but it will be a target to start.

[Operator]

The next question is from Freddie Cheng. Does the company have any plan to expand the ASIC business?

[Kuang Yu Yen, executive]

Quite a while back, I heard a similar question before. And my answer to you is Application Specific IC, arguably all Realtek solutions Application Specific IC. What you are asking, I believe -- actually, it's a little bit tailored for particular customers. So I believe you're asking ASIC for different customers, customized ASIC, I believe that's what you were asking.To that end, we are very open to that. When we develop ASIC target for a particular application, we always keep in mind customers want differentiation. Customer A and customer B, they all want Wi-Fi, let's say, 7, but they all want to use it maybe in a slightly different way to plan their uniqueness. So in that sense, we always work with customers to meet their requirements, even though we are providing standard products. So short answer, yes.

[Operator]

Due to the 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 replay will be available on the IR page of the company website before 6:00 p.m. Thank you, and have a good afternoon.