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Realtek Semiconductor Corp
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Good afternoon everyone, welcome to Realtek 2021 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 PM today. At the beginning, our spokesman will report our third quarter results and give management's remark. After that, we will have a Q&A session. [Operator Instructions]
Note that portion of what presented in this call contain forward-looking statements. Investors are cautioned that forward-looking statements involve risks and uncertainty that actual results may differ materially from the results forecasted or implied in such statements and the investors should not place undue reliance on such statements.
Now I'll pass this call to our spokesman, Yee-Wei.
Good afternoon, ladies and gentlemen. This is Yee-Wei Huang with Realtek Semiconductor. You are listening to the third quarter 2021 webcast earnings release.
First, let us go through third quarter 2021 operational results. Q3 revenue was TWD 29 billion, a 12.1% quarter-over-quarter increase, and a 29.2% increase compared to the same period in 2020. The 3 consecutive monthly record highs in Q3 reflect both the continuing demand strength and the product mix favoring high-end solutions. It should be noted that part of the September record high shipment was benefited by the advanced shipment to accommodate the national holidays in China first, then in Taiwan for roughly the first 10, 11 days of October.
PC-related businesses maintained their strength in the third quarter, resulting in the same 36 to 64 split of PC versus non-PC revenues in the second quarter. Q3 gross margin was 52.6% compared to 50.4% in 2Q '21. The higher gross margin was attributed to the better product mix favoring products with better profitability given a supply limit.
Third quarter operating expense was TWD 9.89 billion, a 34.1% of revenue. An increase in the OpEx ratio is mainly due to a result of 2 things. First, continuing engineering and other investments to expand and secure supply for the future. Second, year bonus and [ accrument. ] Q3 operating profit was TWD 5.35 billion or 18.5% of revenue. Higher operating margin is mainly a result of better gross margin. Amount of loss Realtek recorded TWD 261 million loss. It's mainly due to loss on valuation of financial asset. Some of Realtek's investments experienced market value loss in third quarter. This result in a Q3 net profit of TWD 4.89 billion or 15.9% of revenue.
EPS for the third quarter as a result was TWD 9.57. It is better than TWD 8.43 in the previous quarter or TWD 4.91 in the same period last year. Regarding inventory, third quarter inventory turnover days were at 97 days compared to 82 days in Q2. Inventory increase is mainly caused by uneven availability of various materials in the supply chain, resulting in what being produced first may not be what needed immediately. So we strive for maximizing production output. We do not see the inventory increase to be a problem. Nevertheless, as we're certain what being produced will be shipped in the coming months. We also have balance sheet and cash flow statement for your perusal at your convenience. This concludes Realtek's third quarter financial report.
Forward looking into the fourth quarter, the market generally still sees supply lagging demand. Nevertheless, it remains necessary to pay close attention to the impact brought by the changes in the upstream supply and downstream demand in each application market.
Now let's run down the top product lines at Realtek. On Ethernet, the market growth driver is shifting generally from Consumer to Commercial segments for both PC and non-PC application. Product shipment growth in 2.5 gigabit Ethernet, while dropping in Fast Ethernet. A good example of product mix change favoring high-end solution. Gigabit Ethernet nevertheless remains the largest portion of Ethernet demand and shipment.
Forward looking, 2.5 Gigabit Ethernet will be a focus in 2022 with priority in PC-related broadband PON, Wi-Fi 6 router, and even some 5G applications are subject to supply availability. Regarding switches, switch business continues to be limited by supply, while the demand remains robust for both thumb and managed switch. The growth of managed switch outpaces that of thumb switch, another example of product mix shift favoring high-end solution. The penetration of 2.5 Gig Ethernet switch is limited due to the supply constraint at the present time. It represents a solid growth path for switches for 2022 and beyond, nevertheless.
About Wi-Fi, demand trends and business focus were mainly on PCs and USB dongles in the third quarter. We start to observe some weaknesses in some consumer application. The market demand for Wi-Fi 6 stayed strong in spite of supply shortage. By the end of 2021, the market is expected to have about 30% of PC and 20% of routers of Wi-Fi 6. The penetration may readily double in 2022. Customer projects adopting Wi-Fi 6E are underway. The ramp up will be gradual in 2022.
Next PC Codecs is still in strong demand, indicative of the trend of the PC market. For PC market including Chromebook may reach 347 million unit in 2021, a 15% Y-o-Y growth. Chromebook sales may reach 38 million units by the end of this year, a 27% Y-o-Y growth. Most PC customers we know expect 2022 PC to maintain and further build on the strength of what is achieved in 2021. Bluetooth NIC plays an important part in telco OTT projects to fill in for Wi-Fi during supply shortage. This is expected to continue in 2022. Wearables and remote controllers used in BLE were strong in the third quarter. And the long-term demand is expected to grow. Shipment for TWS using BT SoC is stable as we focus on only brands and high-end solutions. Overall, continuing growth is expected for better -- is expected for BT in 2022.
Last on TV, we've had TV stay flattish in 2021, overall as expected. From 2022 we are working closely with key customers to cope with the continuing supply shortage.
Thank you, Yee-Wei. Now we are entering the Q&A session. [Operator Instructions] First question is from Randy, Credit Suisse. What is your second half outlook for gross margin and the mid-term 42% to 44% is the level or now could be higher?
As long as the semiconductor supply shortage continues, the marketplace is generally a seller's market, giving the seller an upper-hand in product mix and pricing. To the best we can tell, the semiconductor supply is not likely to catch up with demand anytime soon. To this end, we expect to see the product mix in the semiconductor supply chain favoring products, yielding better business performance, including gross margin. The gross margin pressure may start kicking in when supply and demand start balancing out.
Followed by last question. Randy would like to ask, what is your target to grow OpEx in 4Q '21? And what target ratio should we use for OpEx to sales in 2022?
We expect 4Q revenue to slow down this year due to year-end business, re-calibration, and planning. There are no year-end rush in engineering projects and expense payout. Therefore, 4Q OpEx ratio may slightly increase this year. We strive to keep 2022 OpEx ratio lower than the 2021 level. Some non-recurring engineering efforts to qualify new supply capacity are expected to bear fruit in 2022 and beyond.
Next question is from Daniel, Morgan Stanley. Regarding component shortage, what components or industry are still in shortage from your observation?
Although we see some slowdown in selected consumer-oriented applications like TV, IoT, Chromebook in third quarter, the demand of the commercial applications remains strong. Commercial PCs and networking applications including telco tender projects are good examples. Automotive industry also is still in shortage.
Also from Daniel, could the company provide some guidance on the foundry capacity increase in 2022?
Foundry capacity increase in 2022 will be minimal. As I explained before, the new capacity, the fastest one will barely come online in second half of 2022. So overall foundry capacity, worldwide foundry capacity increment in 2022 will be limited by the cost for Realtek as we explained, we are qualifying new foundries to expand our supply base. So that's different from these, terms not changing much, but Realtek will increase.
Next question is from Bruce, Goldman Sachs. About the impact from wafer price hike, what's your customers' feedback so far? Which type of customers by different end demand find it more difficult or easier to accept the price hike?
Well most, if not all, customers are reacting to increasing -- well reacting with increasing complaints and resistance to the continuing price hike. Nevertheless, the price will eventually be determined by the supply-demand mechanism.
Next question is from Rick, Daiwa. His question is, in terms of an application, which areas has Realtek seen softer demands, and how's the impact to Realtek?
We did observe that certain consumer-oriented applications appear to be slowing down. For example, TV, Chromebook, TWS, IP cam, IoT, etc. The impact to Realtek is rather manageable. The supply of cases is quickly reassigned to other applications. Overall that the demand outstripping supply remains the same.
Next question is from Jason, CLSA. What is the current inventory level of Realtek in downstream?
The inventory tend to increase in third quarter is still mainly due to supply imbalance, while produced first from time-to-time may not be what needed immediately as to maximize product output. So regardless we are certain that the inventory level is still manageable in light of the demand trends.
Next question is from William, JPMorgan. How does the company think about demand slowdown in China and its impact?
Well, the slowdown seems to be related to consumer-oriented applications in some region, particularly in China. The demand for other applications in China seem to remain strong. The impact to Realtek is manageable as Realtek serves the global market and the supply capacity can be readily re-allocated.
A follow-up question from Bruce, Goldman Sachs. Any view that you can share regarding recent China power cut and its potential impact to end demand if the situation were to last longer till next year?
Semiconductor-related companies in China seem to be unaffected by the recent power outage. The long-term effect is unclear, although further negative impacts to both demand and supply are within expectation, if the power shortage in China persists for an extended period of time.
Next question is from Kevin, Mizuho. Could company comment on the first half of 2022 business outlook? Overall the demand is strong in 2021, do we have the confidence that the momentum will continue into the first half 2022?
The demand trend for first half 2022 appears to be about the same said in the second half of this year. We see the overall trend in demand in Realtek product is more than sufficient to make up some demand weakness seen in selected segments.
Next question is from Tina [indiscernible] where are some of the biggest opportunities like Wi-Fi 6, 2.5 Gigabit Ethernet, 10G PON, managed switch, mesh router? Are any of this lower due to lack of supply?
Shortage supply has slowed down that upgrade to say Wi-Fi 6, 2.5 Gigabit Ethernet, 10G PON, for example. However, the need for each spec and technology upgrade are real and solid. We expect the migration to new spec and technology will pick up the tempo in 2022, even when supply remains tight.
Next question is from Terence, KGI. Please update for our recent Wi-Fi 6 status. How about peers SoC with time? Do we lift up 2022 Wi-Fi 6E penetration rate forecast?
Well, the market acceptance and demand for Wi-Fi 6 remains strong. Wi-Fi 6 penetration for PCs and routers for example may reach 50% to 60% in 2022 from about 20% to 30% this year. The competition involved some media names of Qualcomm, MediaTek in the mid and high-end, and some China indigenous players in the low-end segment. The adoption of Wi-Fi 6E is expected to start from notebook PC, AP router, and broadband PON application. The adoption rate may be gradual as the supply is still tight.
Still questions on Wi-Fi 6. Bruce from Goldman would like to check Wi-Fi 6 competition landscape, different in product offering, segment focus, pricing strategy versus peers including MediaTek. How is the momentum so far in pricing premium over Wi-Fi 5?
11n, 11ac, and Wi-Fi 6, they co-exist in the market. Their price ratio is roughly 1 to 3 to 4.5. The ASP for Wi-Fi 6E may add another 20% to 30% premium over that of Wi-Fi 6. Old specs may coexist for some time. In time, nevertheless, Wi-Fi 6/6E may grow at the expense of Wi-Fi 5 first. Also in time, Wi-Fi 6, Wi-Fi 5 may replace some 11n. Well, Realtek arguably is the only Wi-Fi solution provider with a comprehensive product portfolio covering all specs for various applications. Realtek continues to focus on PC, networking, consumer, and IoT market by providing Wi-Fi solutions reaching Wi-Fi alliance local programs with high level of integration and low power consumption.
The Wi-Fi 6 is as good as any top tier solution available in the market. In addition, Wi-Fi 6 delivers more value in terms of longer range, lower PON and portfolio completeness. Consumers, customers are attracted to Realtek Wi-Fi 6 roadmap covering for example different antennas and dual-band radio configuration.
Next question is Jason from CLSA, would like to ask about the demand on networking products such as switch, router, gateway, etc. Where the networkings demand still be impacted by component shortage in first half 2022?
Along with everything else, networking products such as switch, router, and gateway have been impacted by supply shortage since late 2020. The demand remains strong as these products are fundamental to deliver ubiquitous connectivity. As far as we can tell, the demand still outstrip supply in the first half of 2022.
Next question. Daniel from Morgan Stanley would like to ask, do you see TV demand contraction in the near term? What's your view on TV demand in 2022?
TV market started to slowdown in the third quarter. A number of factors may contribute to the slowdown. Overall demand in the past 1.5 years, rapid deteriorating panel price, congested sea, and land transportation, softening consumer segment etc. Overall, 2021 TV-10 is expected to drop about 5% and 2022 TV-10 may stay flat.
Next question is from Randy, Credit Suisse. What do you see as key growth driver by product in 2022? Any products under-performing or slowing now as vaccines roll out and potentially cut into the stay at home demand?
The growth drivers for 2022 may come from Wi-Fi 6, Automotive Ethernet, Switch, Bluetooth, PON, Set-top Box, PC, and PC-related. These connectivity solutions provided by Realtek are in great need by the market with or without pandemics and regardless of people working, studying from home, or otherwise.
Next question is from Kevin, Mizuho. How is the demand momentum for China telco building in 4Q 2021? Have we seen different seasonality this year?
The telco tender market in China remains robust, which account for about 50% of worldwide tender market. Delivery for project awarded in second quarter has started in the third quarter. Additional projects are expected to be awarded in the fourth quarter. There does not appear to be changes for all 3 types of tender project demands. PON is still, annual demand 70 million to 80 million units. OTT 60 million to 70 million per year and router, 30 million to 40 million per year.
Next question is from Terence, KGI. TWS now is still in relatively weak demand. Do we expect TWS shipment in 2022 still weak among muted smart phone shipment growth? And how is current ALC penetration rate and its outlook in 2022?
Well in addition to slow mobile phone sales, the TWS market has also been hit by Amazon's shutting down of thousands of China-based online stores in campaign against fake review. Realtek has been focusing only on brands and high-end TWS. The ALC penetration remains limited as the technology failure. Therefore, low product yield has proven to be difficult to overcome. LE Audio may provide the next growth opportunity for TWS. Realtek has lead the market to introduce LE audio solution.
Next question is related to the Auto Ethernet. Could you give us some colors on it? How do we compete with the major players in this segment?
Well, for the auto industry, world-wide car sales will drop by 10 million units due to semiconductor supply shortage in 2021. The main shortage appears to be in MCUs and power ICs. Foundries account for a minor portion of the global automotive chip production. Car makers like, [indiscernible], Volkswagen Group, BMW Group are reporting strong first half sales and profits despite the supply shortage.
The outlook for the auto industry is still bullish. Auto Ethernet is growing stronger than expectation. This segment welcome supply release resulting from the softening of non-automotive application. The concept of software, hardware platform well known to the IT industry. It's taking root in the auto industry. It could help deployment of automotive Ethernet and other IT technologies in the auto industry.
In competition it's only -- there are only a small number of competitors in the Auto Ethernet market. With over 30 years of experience in Ethernet, Realtek enters the Auto Ethernet with an extremely solid technology foundation. Realtek's strengths in high-level integration therefore low AnyPON and small footprint and low-power design give our Auto Ethernet product a competitive edge.
Last but not least, Realtek Auto Ethernet team is second to none in customer support, creating customer intimacy. We listen to customers carefully, and at times propose solution even before they see the need. Case in point, in 2021, Realtek automotive switches lagged in high power comp supporting gigabit 5 and PCIe interface. The innovative design enables Realtek automotive switches to pass many global OEM stringent EMC test and to be designed into a wide range of car motors. Also after almost 3 years of mass production, Realtek automotive products maintain a zero defect record, winning confidence from customers all over the world.
Next question is from [indiscernible]. Can you talk about your market share in IP set-top box market and IPK market? How do you think about the growth rate in 2022?
Okay. So we do not comment on market share. But we can share our observation both IP set-top box and IPK market. They both remain strong, and we believe we have a good position in both market.
Second question, your grade design in Wi-Fi and Bluetooth solution to be the car tier 1 vendors?
Well, not a straightforward answer to you. So auto companies, they actually are very interested in Realtek Wi-Fi and other solutions. So we will work with our customers and they're certainly welcome to use our solution where applicable. What we want to emphasize is that the only product in Realtek that has passed through auto-grade certification is the Ethernet product. Other products today they are not yet so called automotive grade.
The third question is, do you have PCIe gen 4 or 5 product? And mass production schedule?
They are work-in-progress. And we will share the progress in due time.
The next question is from Kevin, investor. Do we have any plan for further price hike next year? When and what products will be impacted?
It really depends on our supplier, as we share we have a feedback from our customers mainly compliance and resistance. So on our own initiative, we never raise the price. But as we explained, the price eventually will be governed by supply demand mechanism. And is in many ways up to our upstream supplier will see what happen next year.
Okay. Next question is from Claire U, investor. What's the die size difference among Wi-Fi 5 and 6 and 6E? Does Realtek have enough foundry supply to support migration from 5 to 6 and 6E?
We have shared with you the ASP ratio of Wi-Fi 5, 6, and 6E. An important factor leading to the price gap is the die size. In terms of foundry supply, current -- the current status really is, no, we don't have enough foundry capacity for anything including to meet all Wi-Fi demand. But we are managing through it. So that's what we can share at this point.
The second question is, we understand the industry is in shortage compared to third quarter. Do we see the gap narrowing. How about next year?
\An analogy we used before is, your -- the gap is large enough, so the comment about gap narrowing or not is not too meaningful, especially if you built on to different applications as we mentioned. Some segments, some applications are slowing down, others are growing. So if we just remain at the high level overall, the gap at this point is still significant enough, that makes whether a comment about whether gap is narrowing, meaningless. And for the next year, at least at this point from what we can see is about the same.
Next question is from Wen-wen Wang from Prudential. When could we expect the OpEx ratio to decrease? How about fourth quarter?
Expense ratio, as we explained, in the fourth quarter likely the revenue may slow a little, while some expense temporal rush in before the end of the year, so the ratio -- the OpEx ratio for 4Q may increase. And we expect or we target in 2022, we believe there is certainly room to reduce the OpEx ratio as some of the recurring, non-recurring engineering costs will start bearing fruit.
Thank you, Yee-Wei. 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 replay will be available on the IR page of the company website before 6:00 PM. Thank you, and have a good afternoon.