Realtek Semiconductor Corp

TWSE:2379

Earnings Call Transcript 2020-Q3

[Ivy Chen, executive]

Good afternoon, everyone. Welcome to Realtek's 2020 Third Quarter Earnings Call. This call will be chaired by Realtek's spokesman, Yee-Wei Huang. The presentation will be available on the company website before 6:00 p.m. today.

At the beginning, our spokesman will report our third quarter results and give a management remark. After that, we will have a Q&A session. You are welcome to type your questions in the box at the lower right corner on the screen. We will answer the questions accordingly. During the call, you can browse through the pages of the presentation anytime.

Now I will pass this call to our spokesman, Yee-Wei.

[Yee-Wei Huang, executive]

Yes. Thank you, Ivy. Yes, good afternoon, ladies and gentlemen on the line. You are listening to the third quarter 2020 webcast earnings release by Realtek. We moved the time to start at 3 p.m. this time in response to your feedback, especially back from our overseas investors and attendees. We hope the new time works well for all of you.

As we speak, COVID-19 is resurfacing in some parts of the world. We wish you all well and healthy by practicing mask-wearing and safe social distancing.

Now let me turn your attention to Realtek's third quarter operational results. First on Q3 revenue, it was TWD 22.4 billion, a 29.2% Q-on-Q growth and a 39.7% increase compared to the same period in 2019. All 3 business groups contribute to the growth. This result clearly reveals that we've had business momentum sustained, benefiting from both continuing demand for mono and better connectivity solutions from work from home and the strong rebound of consumer activities and other market segments in Q3.

Such results result in a PC, non-PC split of 31 to 59 in the third quarter compared to 34 to 66 in the second quarter. Q3 gross margin was 41.4% compared with 44.8% in Q2 and 42.9% in Q3 2019. The gross margin is on the low side of our historic range. This is due to unfavorable product mix. We believe gross margin is likely to improve from here, if not in Q4.

Q3 operating expense was TWD 6.7 billion or 29.9% of revenue. A drop in OpEx percentage to revenue is indicative of Realtek's improvement in operating leverage as our business scales up. Q3 operating margin was TWD 2.57 billion or 11.5% of revenue, which is about the same as the operating margin percentage in the second quarter.

Q3 non-op income was TWD 100 million, this small amount up compared to previous quarter was due to lower deposit interest rate as well as unfavorable foreign exchange rate for the New Taiwan dollars.

Q3 net profit was TWD 2.5 billion or 11.2% of revenue. This is a 0.5 percentage point decrease Q-on-Q. So this leads to the EPS of TWD 4.92, better than the TWD 3.97 in Q2 and TWD 3.78 in Q3 2019.

Regarding inventory, Q3 inventory turnover days was at 62 days compared to 89 days in Q2. The significant reduction in inventory is total of 2 things: first, very strong market demand; and second, tightening supply capacity. We also have the balance sheet and the cash flow statement for your perusal at your convenience.

So this concludes Realtek Q3 financial report. Forward-looking, we see the momentum of customer demand for various product application continue in Q4. Nonetheless, we have to watch closely as the supply chain capacity constraints, the changes in international affairs as well as COVID-19 pandemics may impact the macro economy and end market supply/demand.

Now I'll run down the top 5 product lines at Realtek. On Ethernet, after a slow second quarter outside of the PC segment, customers and the market seem to be eager to make up the loss. We call that rebound with a vengeance. The strength in 3Q is expected to continue in Q4. The end applications include PC, IPK, network video recorder or surveillance and USB NIC.

On Switch, fast Ethernet, Gigabit Ethernet and Managed Switches were all in high demand in the third quarter, expected to continue in the fourth quarter. Driving forces include the demand for surveillance, security, work from home and Wi-Fi 6 upgrade. PON demand are also strong in 3Q and 4Q as second half will be the peak season for cable tender project awards this year.

On Wi-Fi, Q3 was strong in many fronts, including tender projects, PCs, routers, TV, IPK and IoT. The trend is expected to continue in the fourth quarter and last at least until first quarter 2021.

On Bluetooth, in addition to TWS, whose demand has been picking up since the late Q2, other applications such as those found in TV, OTT, smart speakers using, we call it BT NIC, or remote controllers and wearables using Bluetooth Low Energy were in high demand in Q3 and expected to continue in the fourth quarter.

Last but not the least on TV, after a peak in the third quarter, the TV demand is expected to slow down seasonally in the fourth quarter. Nonetheless, the drop is expected to be mild.

Lastly, let me briefly come back on the supply chain capacity. We observed capacity tightness on a global scale. As previously commented, we have to dig into our inventory in some cases. Our supplier capacity is insufficient to meet the demand. Such tightness may continue until at least Q1 2021. We have to watch closely as it might impact our final product delivery and revenue. Thank you.

[Ivy Chen, executive]

Okay. Thank you, Yee-Wei. Now we are entering the Q&A session. Please type your questions in the box at the lower right corner on the screen. We will reply accordingly.

Now the first question is from Daniel Yen, Morgan Stanley. His question is, how do we see the demand from PC market in both fourth quarter 2020 and 2021? From Realtek's view, do we see any risk of inventory adjustments?

[Yee-Wei Huang, executive]

Thank you. So we expect the strong demand from the PC market to continue in 4Q 2020, but the actual shipment may be limited by the supply chain capacity. Overall, the PC market is expected to grow in 2020. The growth mainly comes from the demand of work from home and education.

The PC market trend is expected to continue in at least first quarter 2021 or even second quarter 2021. The prospect -- beyond that, the prospect for the PC market is unclear for the second half next year. The inventory level for the PC market is generally low now. We do not see the risk of inventory adjustment at this time. Thank you.

[Ivy Chen, executive]

Okay. Thank you. The next question is from Randy Abrams, Credit Suisse, regarding supply finance and own inventory. How is Realtek's own inventory days now? And do you have any product lines being financed, limiting your revenue? How much are you going short of demand now, if at all?

[Yee-Wei Huang, executive]

So Q3 inventory turnover days, as we just reported, is now at a low 62 days. In general, supply chain capacity constraint is a limiting factor now to revenue. In the third quarter, a good portion of the shortage was fulfilled by prior inventory. This will face increasing pressure in the fourth quarter as the inventory level drops. Thank you.

[Ivy Chen, executive]

Thank you. The next question is from Edward Leung, Invesco. Do we see any progress on the funding support? How many wafers of NIC are you planning to transfer to other foundries? Foundry costs are increased now? If yes, can we pass the cost to the clients?

[Yee-Wei Huang, executive]

Right. Again, foundry capacity, in general, is tight. We use several foundries, including NIC. And as our demand, as our company continue to grow, scale up, and the demand is tight, we are looking for expanding our foundry partners, exploring some foundry we haven't used before.

So in terms of foundry costs or price, we always say price is a result of negotiation. So what's different now is that there are cases where we involve our customers to join the discussion with the foundries, together, to decide price, quantity in a way that's acceptable to all concerned parties. So this way, we manage the supply/demand with manageable impact to Realtek margin. Thank you.

[Ivy Chen, executive]

Okay. Thank you. The next question is raised by Aaron Jeng, Nomura. Could you give us some colors on your set-top box SoC products, including the percentage of revenue contribution to customers and regions? Also the margin, compared to the company's average?

[Yee-Wei Huang, executive]

Yes. Well, as a matter of policy, we do not break down revenue contribution by product line. Neither do we comment on the names of our customers. What we can share is that our set-top box SoC customers are mainly in North America and Asia at this time.

As for the margin impact, it is still manageable, as the product line is small in scale. So far I can say similar to other major product lines, we continue to better our cost structure of the product line growth. Thank you.

[Ivy Chen, executive]

The next question is raised by Bruce Lu, Goldman Sachs on TWS product line. Here, he would like to know the year-end demand push, the phasing of the new ANC projects and the competitive net gap change and price trends.

[Yee-Wei Huang, executive]

So we see TWS demand rebounded in third quarter in both China e-commerce and global brands. ANC pressure on non-ANC products resumed as the demand rebounded. Nevertheless, some TWS customers now choose quality and profit over quantity and market share. Realtek is maintaining a solid position in balancing profitability and market share in new design wins, and we see ANC still not that mainstream yet but is a preferred feature for 2021 TWS projects. The price gap between ANC and non-ANC is still big today, more than 2x difference.

As competition pick up the tempo and -- well, as the market pick up the tempo to resume, so do competitor competition. The main competitions are still among what we call the ABC today. What we observed is that second or lower-tier competitors will be challenged in securing supply capacity at the present time. Thank you.

[Ivy Chen, executive]

Okay. There's a follow-up questions by Bruce. He said the OpEx ratio down a lot in Q3 due to the operating leverage. As Realtek is going to maintain current revenue level, can we expect that OpEx ratio can be below 30% moving forward?

[Yee-Wei Huang, executive]

So Realtek definitely will strive for further operating leverage. But we don't really have a firm schedule or target to share, and we do see room for further improvement. Thank you.

[Ivy Chen, executive]

The next question is from Kevin Wang, Mizuho. His question is regarding the development status of our Automotive Ethernet-related products. Do you have any plan to launch any new products or enter new markets in the near future?

[Yee-Wei Huang, executive]

Okay. Well, the automotive industry seems to rebound in China, and Realtek Automotive Ethernet product shipment is expected to continue the steady growth in the next few years. This is because the typical automotive design win will run for 5 to 6 years, and we're have not still aware for design wins up to now. Now we are bidding for 2025 models and beyond.

And in terms of our new product, while Ethernet Switches and PHYs are still the main staples of Automotive Ethernet product line, so we expect automotive multi-gig and the low speed 10-megabit per second technologies are ready at Realtek, although we see large-scale deployment in the industry will not start until 2025.

[Ivy Chen, executive]

Okay. The next question is from [ Meryl Chu ] of [indiscernible]. You mentioned that 4Q will see the momentum from the various product lines to continue. Does this mean the fourth quarter sales will see quarter-over-quarter growth? How will the product mix shift into fourth quarter? Will we see the gross margin back to 43% to 44% and the funding cost impact in fourth quarter? It's a long question.

[Yee-Wei Huang, executive]

Okay. Yes, I think we have actually touched upon a little bit here and there, but let me go through this. So the 4Q momentum, we do see it continues. And -- but whether there will be a Q-on-Q growth or not, as we mentioned, supply will be a constraint. So we will not be able to tell you for sure at this time as we work hard to fulfill our customers' and market demand.

The product mix here, again, sometimes it's not exactly up to us. It depends on how our customers put in their orders. And so it's really premature to comment on the product mix, let alone the gross margin level. So as to repeat that, we say we believe the gross margin, we do believe, will come back, if not in Q4.

And in terms of the foundry costs, also we mentioned that in special cases, we will involve our customers to negotiate with the foundry from price versus quantity, so to minimize the impact solely on Realtek. Hope this answered the question.

[Ivy Chen, executive]

Thank you. The next question is from Rick Hsu, Daiwa. His question is our initial outlook for the top 5 product lines in 2021 and the main growth drivers of the company.

[Yee-Wei Huang, executive]

Okay. So -- well, among the top 5 product lines for 2021, we see growth drivers led by Wi-Fi and Bluetooth. Although we'll also say that we select the pocket of opportunities for the new fab, 2.5 gigabit Ethernet deployment. And for Switch, there's opportunity like in Managed Switches, while TV mainly will stay flattish after 4 consecutive years of strong growth.

We should also comment that other growth opportunities beyond the top product lines, those may include codec comp, Automotive Ethernet, set-top box and IPK. Thank you.

[Ivy Chen, executive]

Okay. Now is the question from [ Sunny ], UBS. First question is related to Wi-Fi 6. What is the current penetration rate of Wi-Fi 6 in different applications? And how does Realtek compete with the market leaders who have launched their solutions in early 2020? And which segments do we expect to see more share gain?

[Yee-Wei Huang, executive]

So when we talk about Wi-Fi, we usually will exclude mobile phone. So outside of the mobile phone, the Wi-Fi 6 penetration is still modest as far as we can tell.

Compared to some reports, Realtek estimates the Wi-Fi 6 penetration, for example, into the PC market is about 10% to 20% this year. This may go up to 20% to 30% in 2021. So later than some competitors, we have Wi-Fi 6 solution timely, we believe, considering that the interoperability test standard was not set until the third quarter of 2019.

And our products are meeting all Wi-Fi 6 spec requirements. We have Wi-Fi 6 solutions winning the competition in latency reduction by being very concurrent and we also have technology that do range expansion. Above all, Realtek always provides second-to-none engineering service and support our customers. This is definitely a strong competitive edge of Realtek. Realtek Wi-Fi 6 is expected to grow steadily in 2021 in PC, mobile, sound card, AP/Routers, broadband, et cetera. Thank you.

[Ivy Chen, executive]

Thank you. The next question is from CLSA, [ Brian ]. His question is that TSMC specifically mentioned IoT being one of the growth drivers in third quarter 2020. How does Realtek compete with MediaTek and others with Wi-Fi Bluetooth solution?

[Yee-Wei Huang, executive]

So Realtek competes in general through very unique perspective. For IoT, pretty much follow the same direction. First is through our technology competency in high level of integration and low power design. Realtek has many in-house connectivity IP that complement one another, so with total combination.

We offer solutions such as IoT audio and IoT video. The former, enabled voice control interface for IoT devices, the latter enables specially powered camera devices such as body cam and GoPros. These are products may be very hard for our competitors to follow.

Second, again, we'll have win on second-to-none customer services. In IoT, this includes thinking ahead of our customers' needs and to have ready not only a full suite of reference designs, but also we made ready solution partners who can bridge customers' application with the cloud service of their choice, for example, Google, Amazon, Ali Cloud, et cetera. These are our competitive edge. Thank you.

[Ivy Chen, executive]

Okay. We have 2 questions from [ Warren Tsu ], Prudential. The first question is due to the foundry financing issue. Will you migrate your -- more production products from 8-inch to 12-inch or from 40-nanometer to 28-nanometer? And the second question is, do you have any USB 4.0 or PCI-e Gen 4 products? If yes, can you talk more about this?

[Yee-Wei Huang, executive]

Okay. First part is about foundry, 8-inch versus 12-inch. For sure, the 12-inch capacity, it is a more limited than the 12, and when you utilize 12, most of them, they are 40-nano or more advanced. So do we take this into consideration? Most definitely, yes. For new product design, we definitely will put that as a consideration. And whether the existing product warrant a migration, that is not an easy question. Case by case, very different. Suffice to say that, these are all the possibility. We leave no stone unturned to try to optimize our product production.

And the second part of our USB 4.0 and PCI-e Gen 4 product. The short answer is, yes, they are in planning. These are all relatively new specs. And since these are work in progress, I do not have too many details to share. But we'll share with you that, yes, we are working on products with USB 4 and PCI-e Gen 4.

[Ivy Chen, executive]

Okay. Thank you. The next question is from Eric Chen, KGI Securities. So Realtek talked about its opportunities in Chromebook, how was the contribution in Q3? Are we seeing any margin dilution from more Chromebook in just 2 months?

[Yee-Wei Huang, executive]

So Chromebook definitely has quite significant growth this year, and for Realtek, all we see, really, Chromebook versus notebook in terms of the solution we provide, there's not a lot of difference there. So most of the components, for example, codec, for example, PC cams, now they are applicable to Chromebook as to notebook.

And if you take into consideration many of the OEMs, or OEM for that matters, they do both, but not just one or the other. So when we think about that, if, let's say, we have been selling codec to this OEM who has been purchasing our codec for notebook, and they find the design is applicable to Chromebook, well, you will assume there will be no 2 prices, there's only 1 price.

Okay. So in general, my answer is, not a whole lot of difference there. So we will have the opportunity for notebook and Chromebook, they're equally good. Thank you.

[Ivy Chen, executive]

Okay. Thank you. The next question is from William Yang, JPMorgan. Please comment on the TV business. The TV SoC business growth looks impressive in 2020. Do you expect further growth off a high base or continuing herein?

[Yee-Wei Huang, executive]

So well, first, we definitely see headroom for growth for Realtek TV products. Although earlier, we say the growth from here is expected to be mild in the coming year compared to what we have seen in the past 2 years.

We have to also take a look at the market landscape. The global TV market appears to be flat this year, even with the strong rebound in the second half. And from what we can tell, we are not expecting growth in our overall TV market in 2021, even though at the current plan the Olympics will be held next year.

Another important thing is the migration to 4K slowed down this year because during pandemics, when people buy a TV, they are more cost-sensitive and may not choose the high end one. As a result, we are seeing that the 4K penetration pretty much stayed at the 50% level this year, same level as last year. And 8K ramp-up is even slower than we originally expect. Now due to -- other than the same factor of COVID, lower 4K ramp up, other than that, also due to, in the case of 8K, component shortage, panels, memory. So companies will rather use the limited resource in a product that they believe that will sell better.

But I will tell, of course, our technology are ready. So we standby to capture opportunities when they are open. Thank you.

[Ivy Chen, executive]

Okay. The next question is from Sebastian, CLSA. Which IT products does Realtek have to boost due to fear of supply constraints, if it's more Chromebook-related, IT or something else?

[Yee-Wei Huang, executive]

Probably the best way to answer this one is that the products using 8K -- I'm sorry, 8-inch wafer tend to be hit harder than those use 12-inch wafer. That really is the deciding factor there, not particularly in terms of application. Thank you.

[Ivy Chen, executive]

Okay. Thank you. The next question is from Edward Su of Grand Alliance. Do we see any overbooking? If yes, in which segment?

[Yee-Wei Huang, executive]

Well, overall market supply/demand is not in balance as we speak. And supply shortage tends to breed overbooking. But nevertheless, market inventory is generally low at this point. Therefore, it is hard to tell whether -- so it's hard to tell where the overbooking may be. We will need to wait until mid first quarter 2021 to have a better view.

[Ivy Chen, executive]

Okay. So the next question will be from an individual investor. His question is how many percent from China -- fleet of China or non-China. And is the product line unstable by COVID-19?

[Yee-Wei Huang, executive]

Product line from China, non-China. I think the question is about where our customers are, where we'll ship the product to.

So in general, we ship our products to the ODM and the ODM, up to now, still a good percentage are in China. Although I'm sure you have all read that various ODM, as a matter of risk management, moving their facility outside of China. So I don't have the exact percentage, but I can tell you that the percentage in China, in time, is reducing.

And in terms of production, in general, we don't see that hit by COVID-19. Most of our product -- our ODM and our supplier, they maintain pretty much full operation, other than for a very short period of time, in February this year. Otherwise, for all we know, they'll be in full operation, so not hit by COVID-19. Thank you.

[Ivy Chen, executive]

Okay. Due to the time constraints, the following will be the last question for the call. [ Martina Huang ], would like to ask the status of China Telecom bidding this year and outlook for next year.

[Yee-Wei Huang, executive]

In terms of China Telecom bidding tender projects. The momentum seem to be clear is resuming in second half this year. And for next year, we believe the TAM will be about the same. So 3 segments here, 3 types of tender projects. For set-top box, the annual TAM is about TWD 40 million, these are low-cost products followed by Wi-Fi. AP/Router, the TAM here is TWD 25 million. They are moving to Wi-Fi 6 in the second half this year and expect to grow in 2021. PON, will be the largest segment, with a TAM of TWD 90 million, although the actual deployment this year seems to be a mere TWD 40 million due to the COVID-19. The list that we are seeing for PON is shifting for 10G PON and Wi-Fi 6 in 2021. Thank you.

[Ivy Chen, executive]

Okay. Due to the time constraints, we have to 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 p.m. Thank you, and have a good afternoon.

[Yee-Wei Huang, executive]

Thank you.

[Ivy Chen, executive]

Thank you.