Realtek Semiconductor Corp

TWSE:2379

Earnings Call Transcript 2022-Q4

[Operator]

Good afternoon, everyone. Welcome to Realtek's 2022 Fourth Quarter Earnings Call. This call will 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 fourth 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. So good afternoon, ladies and gentlemen on the line further on behalf of our Realtek. Let me wish everyone [Foreign Language] have a great year of the Rabbit. You are currently participating in the fourth quarter 2022 webcast earnings release hosted by Realtek Semiconductor Corporation.

Now let us go through the fourth quarter 2022 operational results. Q4 revenue was TWD 21.76 billion, a 26.9% Q-o-Q drop and a 20.5% decline compared to the same period in 2021. End market weakness and supply chain focus on lowering inventory are the main reasons leading to a Q-o-Q and Y-o-Y drop.

Q4 gross margin was 43.7%, a 4.4 percentage point drop compared to the previous quarter. Three main reasons for the drop are: first, change in product mix; two, average cost increase and three, accounting loss from slow-moving inventory.

However, Realtek continues to follow the market and customers' needs to develop a high-value product portfolio. Meanwhile, most of the inventories so written off for accounting purpose, still meets the market needs and can be sold during the year. To this end, we believe that the mid- to long-term gross profit margin may be better than that before COVID-19.

Q4 operating expense was TWD 7.73 billion or 35.5% of revenue, meeting company's expectations as OpEx ratio normally peaks in the fourth quarter. Due to the market headwind we do not expect the OpEx ratio to improve in the short term. We remain confident to leverage our economy of scale to lower our OpEx ratio as the company scales up in the long term.

Q4 operating profit was TWD 1.77 [ billion ] or 8.1% of revenue. Lower revenue, gross margin and higher OpEx ratio led to the sliding of operating profit ratio. Q4 non-op income was TWD 484 million, gained from increased government grants and proper hedging against U.S. dollars [indiscernible] price for a higher non-op income compared to the last quarter.

Q4 net profit as a result was TWD 2.13 billion or 9.8% of revenue. Q4 EPS, as a result was TWD 4.16, above 50% of the third quarter level. Regarding inventory, Q4 inventory turnover days were at 204 days, a sharp 67-day increase from the 137 days in Q3.

As we explained in the third quarter earnings call, we put priority on supporting the distributors and customers to manage their inventories in the third quarter. That results in in-house inventory increase was within expectations. Most of these inventories are effective ones and will be gradually digested.

We target to see the inventory return to a lower level by the end of the first half.

We also have fourth quarter balance sheet and cash flow statement for your reference at your convenience. Now we will also quickly go through Realtek 2022 full year operational results. 2022 net income was TWD 111.8 billion, achieving another year of record high revenue with a 6.0% Y-o-Y growth.

2022 gross margin was 48.9% compared to 50.4% in 2021. 2022 operating expense was TWD 38.9 billion or 34.8% of revenue compared to 34% in 2021. 2022 operating income was TWD 15.7 billion or 14.1% of revenue, a 2.3 percentage point drop from 16.4% in 2021.

2022 non-op income was TWD 1.20 billion compared to TWD 250 million in 2021. 2022, net income was TWD 16.2 billion or 14.5% of revenue compared to 16.0% in 2021. As a result, 2022 EPS was TWD 31.62 compared TWD 33 in 2021.

This concludes Realtek fourth quarter and 2022 financial reports. Impacted by the macro economy conditions, the end market demand in the near term is slow and the semiconductor industry continues its inventory adjustment.

Further, the uncertainty arising from the lifting of the COVID-19 controls in China, and the Lunar New Year holidays are impacting the operations of [indiscernible] factories. The fourth quarter operating outlook is prudently conservative. Despite the short-term headwind, we will still strive for our 2023 annual revenue, no worse than that in 2021.

Next, let's review the top product lines at Realtek. First, we observed that PC versus non-PC revenue to be approximately at 26:74 in the fourth quarter, a notable drop in PC percentage due to the PC market slowness and high customer inventory.

Now on the Ethernet. Inventory management took a central stage in the fourth quarter for PC Ethernet and other Ethernet customers compounded by the depressed macroeconomic conditions, including interest rate rise, inflation and COVID lay off.

We saw a sharp drop in Ethernet orders in fourth quarter. Entering 1Q 2023, inventory digestion is expected to continue in both PC and network markets, while we are seeing signs of order returning.

Expecting the market conditions to be better in the second half, we will have [indiscernible] customers to push for technology migration from 1 gigabit Ethernet to 2.5 gigabit or even 5-gigabit Ethernet.

The switch business was anemic in the fourth quarter. Due to the inactivity of telecom projects under the strict Zero COVID policy in China and strong U.S. dollars in developing countries.

Many factories in China decided to have an extended Lunar New Year holidays in first quarter upon the total lifting of the COVID control. Despite the short-term setback, the market strength is expected to return some in 2023 and more in 2024 to demand spec upgrades, for example, for multi-gig switches.

Meanwhile, we have share gain in managed switches continues slowly but surely. About Wi-Fi. Key Wi-Fi markets, including PC, broadband, router, consumers, et cetera, all grow remarkably in the fourth quarter. Entering the first quarter, customers tend to hold back and issue rush orders quite necessary in light of: one, high-inventory; two, less working days.

Regular demands are expected to bounce back in late fourth quarter or starting second quarter. In spite of the turbulence, Realtek Wi-Fi 6 now accounts for roughly 20% of our Wi-Fi business. It is expected to at least double within realtime in 2023.

We expect Wi-Fi 4, 5 and 6 to coexist in the foreseeable future with Wi-Fi 7 adding to the mix in 2024. Wi-Fi 6E more likely than not, will be a transitionary solution for at least 2 reasons: first, still many countries, including China, India, Taiwan and most countries in Southeast Asia and Africa have not approved Wi-Fi in 6 gigahertz.

And two, Wi-Fi 7 introduced many additional features, for example, multi-link operations to effectively use 6-gigawatt band along with the existing 2.5 gigahertz and 5 gigahertz band.

On Audio Codec according to IDC, shipments, PC shipments, including desktops, notebooks, chrome books and apple were 292.3 million units in 2022, representing a 15.5% drop compared to 2021. Within 2021, the fourth quarter drop was most pronounced at 29% Y-o-Y.

We have Audio Codec drop in Q4 with above market average as we gave priority to help customers manage their inventories. The PC market is likely to drop further in the fourth quarter '23 compared to the fourth quarter last year.

Most customers forecast the PC market to drop about 5% Y-o-Y this year. For non-PC applications, nonetheless, we see growth opportunity in 2023, especially in gaming related areas.

Last but not the least, on TV. Worldwide TV shipments appear to be around 197 million to 202 million last year. It is expected to be between 190 million to 197 million units in 2023, a slight Y-o-Y drop.

Outside opportunity, if any may come from high frame rate TV targeting at gaming segment. Total TV business is expected to hold steadily in 2023 and we continue to see headroom for growth.

[Operator]

[Operator Instructions] Now the first question is from Randy, Credit Suisse. After the sharp fourth quarter declined, have you see first quarter stabilizing? How do you see first quarter stabilizing? Do you another sharp decline from a lower base. Do you expect a pickup post the Chinese New Year and whole year top line target?

[Yee-Wei Huang, executive]

Well, further, many of the macro challenges seen in the fourth quarter are still with us in the first quarter. For example, high inventory in semiconductor supply chain, inflation, geopolitical conflicts, especially including the war in Europe. Some conditions are improving, while others may get worse before they become better.

Further, first quarter with less working days is traditionally not a strong quarter in terms of revenue. All things considered, we expect the first quarter to be the trial of the current business cycle. Some segments are likely to start coming back after the Lunar New Year.

We expect second quarter business to be better than that in the first quarter and second half better than the first half. Overall, we strive for 2023, no worse than 2022.

[Operator]

Next question is from William, JPMorgan. How does China reopening impact our Realtek business?

[Yee-Wei Huang, executive]

Okay. The short-term impact appears to manifest itself in 2 interrelated ways. First, a smaller workforce due to a higher number of confirmed cases, and Two, longer Lunar New Year holidays for some companies.

To this end, business activities in China is slow overall as we speak. The slowness has a direct impact to the business performance of Realtek and our customers. For Realtek operation in China, nonetheless, we see the confirmed cases within the company appear to have peaked and engineers are mostly back to normal schedule.

Therefore, the impact for Realtek day-to-day operations in the China is minimal.

[Operator]

Next question is from Daniel, Morgan Stanley. What will be the key growth drivers in 2023.

[Yee-Wei Huang, executive]

Okay. 2023, look flattish compared to 2022 at the first glance. The growth, as we strive to achieve may come from spec upgrades in Wi-Fi, Ethernet and PON such as the continuing rise of Wi-Fi 6 penetration rate, the adoption of multi-gig Ethernet and the growth of 10G PON. Automotive Ethernet 5 and switch are also expected to outperform with respect to the corporate average, although its base is still relatively small.

For CE, Codec, Bluetooth and TV, the growth may come from expanded applications.

[Operator]

The third question is still from Daniel, Morgan Stanley. He would like to ask, when do you think the revenue might bottom? How would the seasonality pattern differ from previous years?

[Yee-Wei Huang, executive]

As previously stated, first quarter may be the trial of the current cycle. We see second quarter revenue better than the first quarter and second half better than the first half. A reversal from the previous year and back to the normal seasonality with the [ vengeance ].

[Operator]

Next question is from Rick, Daiwa. This question is about gross margin. How's gross margin outlook in 2023 on inventory adjustment and likely pricing pressure? And would Realtek's gross margin be back to pre-COVID level in the short term?

[Yee-Wei Huang, executive]

The gross margin is under pressure in the short term to reconcile with all the accounting loss from slow-moving inventory and pricing pressure from the adversarial market conditions. It may be the second half before we see gross margins stabilizing.

In the mid to long term, however, we do believe that the gross margin can be better than that before COVID-19 because of the sustaining product mix changes.

[Operator]

Next question is from Terence, KGI, regarding OpEx. Can management give us some hints about the first quarter '23 and 2023, OpEx and OpEx ratio?

[Yee-Wei Huang, executive]

Well, due to the market headwind, we do not expect OpEx ratio to improve in the short term. We expect the 2023 full year OpEx ratio remains at a similar level compared to 2022.

[Operator]

Next question is from Bruce, Goldman Sachs on overall PC demand. For the last 3 months, we continue to see direct deteriorated PC demand. Do we see the clear bottom in recovery for the overall PC demand?

[Yee-Wei Huang, executive]

Most of the PC customers we talk with believe a mild Y-o-Y decline of roughly 5% for the PC market in 2023. This implies clearly a better second half than first half this year for the PC market. Stated differently, the PC market is expected to bottom up by the second quarter at the latest.

[Operator]

Next question is from Aaron, Nomura. Considering the positive view on networking segment for 2023 from spec upgrades, what sales percentage do we expect this segment to account? How would the mix change impact the gross margin beyond?

[Yee-Wei Huang, executive]

Okay. Suffices to say that Communication Network segment has contributed to the largest portion of Realtek business for many years. It is expected to outgrow others this year driven by the spec upgrades.

Note, however, spec upgrade alone may help ASP and the top line but not necessarily gross margin. Realtek communications network products continue to venture into new market segments that reward advanced spec and features with a premium.

An example will be Realtek's continuing progress in managed switches. Further, there are opportunities to integrate value-added features such as AI, audio, video into communications network, product as Realtek accumulates increasing number of relevant IPs from other business operations.

Case in point, a router SoC with AI QoS can markedly improve user experience for gamers and online live streamers. Such integration is oftentimes welcome for mid high-end applications. It can boost both revenue and more often than not gross margin. That is, with the product mix trends towards mid-high and it helps achieve gross margin improvement.

[Operator]

Next question is from [ Martina ], Fubon. Please share your view on the outlook or directions of telco project in China impacted by COVID in 2023.

[Yee-Wei Huang, executive]

While some tender projects awarded in 2022 did not actually led or were not deployed by the year-end. We estimate the actual deployment of China telco projects in 2022 maybe 70 million to 80 million units for PONs, 50 million to 60 million units for routers and 30 to 40 million units for set-top boxes.

Now that China has lifted the zero control, the zero COVID control, the outlook for telco projects is positive. The TAM for telco tender projects in 2023 may be 80 million to 90 million units for PON, 60 to 70 units -- million units for routers, and 50 million to 60 million units for set-top boxes. We shall pay close attention to the development after the Lunar New Year.

[Operator]

And a follow-up question on telco project from Randy, Credit Suisse. Are there any spec upgrades in the telecom project? How are the activities in overseas markets?

[Yee-Wei Huang, executive]

We observed that all telco routers in China may go for Wi-Fi 6 in 2023. While most 2.5G and 10G PON may go without Wi-Fi. In contrast, we see some developing countries outside China may choose to stay with Wi-Fi 5, AC1200, for example, instead of Wi-Fi 6, AX1800, for example, due to project concern.

[Operator]

Next question is from Kevin, Mizuho. What is your updated expectation for Wi-Fi 6 adoption rate in PC and router, respectively in 2023.

[Yee-Wei Huang, executive]

Wi-Fi 6 has achieved 50% to 60% penetration in PC and 40% to 50% in routers in 2022 as expected. It is expected to get at least another 10% market share -- market position in 2023.

[Operator]

Next question is from Randy, Credit Suisse. What is your development progress on Wi-Fi 7 and timing for mass production and the initial targeted application.

[Yee-Wei Huang, executive]

Wi-Fi 7 interoperability prospects as we expand it for hosted by Wi-Fi alliance have been ongoing since fall 2022. It is expected to continue until midyear this year. Realtek is actively participating in the process.

Customer design is -- about the Realtek Wi-Fi 7 is also ongoing. We expect more volume, mass production in 2024. The initial target market will include PC, router and broadband 10G PON.

[Operator]

Next question is from [indiscernible], a follow-up questions on Wi-Fi. Please update on the price differences among the different generations of Wi-Fi.

[Yee-Wei Huang, executive]

Okay. By fourth quarter, the ratio between Wi-Fi 4, 5, 6 and 7 are roughly 1:3:4.5:9.

[Operator]

Next question is from Jason, CLSA. Regarding networking market share, do you see U.S. players now have better wafer supply to get market share? Do we see Chinese players get market share with lower ASP?

[Yee-Wei Huang, executive]

We see competition is generally back to the pre-COVID pre-shortage period. The differences are: one, Realtek has gained footing in some accounts that we could not get in before; and two, spec has moved up another launch.

To this end, we shall find ourselves in a familiar yet improved position, we put priority on providing best cost performance solutions with second none customer services and avoid segments that compete purely on price.

[Operator]

Next question is from SSSA, [indiscernible]. Can you talk about your view on your gap with various Chinese competitors like Espressif or they can -- are they catching you up?

[Yee-Wei Huang, executive]

To explain the spec, continue to go up and also passing the interoperability test and Q test they are important. So we see the gap between Realtek and Chinese competitors still exists.

[Operator]

Next question is also Ethernet related, from Terence, KGI. Can Realtek provide recent updates on the Automotive Ethernet product line. What is the future product road map of the company's Automotive Ethernet segment? Has Realtek seen slowing automotive demand or auto electrification train given macro uncertainties.

[Yee-Wei Huang, executive]

Well, first off, it may be worth repeating that Automotive Ethernet is agnostic to the choice of electrification or not. Both industry vehicles and cars running on gasoline are embracing Automotive Ethernet, a in-vehicle network infrastructure.

And electric cars with auto Ethernet, nevertheless, renders itself much like TCP/IP-based IT platform. That is easy to scale and build applications on it. We see the trend for more vehicles to adopt auto Ethernet, unstoppable.

Future product road map revolves around higher speed and better security. Nevertheless, we see a number of new automotive OEM projects originally scheduled for 2025, 2026 production delayed due to supply shortage. This has caused a push out of the new component product road map accordingly. Existing solutions will have an extended product life in the meantime.

[Operator]

Next question is from William, JPMorgan. Realtek demonstrated the audio solution 5575 for the automotive application. Could you give us more color about the strength, mass production timing and potential TAM for this product?

[Yee-Wei Huang, executive]

Okay. Realtek's intelligent automotive noise supression technology with voice at the part number ALC5575 uses a pre-enrolled voice print of a specific user, retaining only specific user's voice. So a far end listener can readily hear talker clearly.

This technology integrates Realtek's AI beamforming and noise suppression, making it possible to remove voices from tires, windshield, rain et cetera in a moving vehicle. The solution will be ready in the first half this year, such technology can be most readily deployed to an industrial vehicle, which will be our initial target market.

Per Wall Street Journal, global sales of fully electric vehicles totaled about 7.8 million units in 2022 and made up about 10% of the 80 million new cars sold last year. Some analysts forecast battery-powered EVs will amount to 20% of global sales by 2025 and 59% by 2035. These are all our target market.

[Operator]

Next question is from Aaron, Nomura. Please kindly provide an update on high-speed interface products such as USB4 and PCIe Gen 5.

[Yee-Wei Huang, executive]

Realtek's first USB4 product is a USB4 host controller. It is the first full feature USB4 solution in the market. The sample has been delivered to customers for engineering filed. The target NPE type is in the second half this year.

Realtek's GpiC5.0 is planned for 2023 readiness.

[Operator]

Next question from Terence, KGI on R&D headcount. What's our ideal R&D headcount in 2023? And how would it impact your R&D expense in 2023?

[Yee-Wei Huang, executive]

Currently, about 87% of Realtek, 6,700 employees globally at the end of 2022 are R&D engineers. We expect the number to grow modestly in 2023 depending on the business condition. All managers are prudent in hiring.

We believe that R&D expense as a percentage of sales will be about the same level of that last year.

[Operator]

Next question is from Daniel, Morgan Stanley. What's your view on TV shipment growth globally and Realtek's TV SoC growth in 2023.

[Yee-Wei Huang, executive]

I believe we mentioned earlier, [ Viva ] TV TAM is expected to be around 190 million or 197 million this year, a slight Y-o-Y drop. Upside opportunity is only may come from high-frame-rate TV targeting at gaming segment. Realtek TV business is expected to hold steadily in 2023.

[Operator]

Next question is from Jason, CLSA. Regarding Bluetooth, how should we think about the TWS market in 2023? And the focus of Realtek's Bluetooth product line.

[Yee-Wei Huang, executive]

While Realtek remains committed to the Bluetooth TWS solution. Although we are seeing many Bluetooth products now are competing purely on price. We currently -- we are staying away from the basic TWS market competing solely on price. We are focusing on global brand customers, gaming applications and the new BLE audio applications.

We are also combining wearables and TWS into 2 in 1 solution that provides a double-duo wearable solution that is BLE data with BT classic audio and is a classic audio with BLE audio. A BLE audio becomes commonplace in the near future, Realtek will help customers enjoy time-to-market benefits for BLE audio watch TWS and various related applications.

[Operator]

Next question is from Leo Ching. Could you share your view on Taiwan Chip Act?

[Yee-Wei Huang, executive]

As we speak, Taiwan Chip Act is still under discussion in the legislative [indiscernible] to the best of our knowledge. So it will be premature to comment other than saying that as an industry member, we certainly welcome government support of the chip industry.

[Operator]

Thank you, Yee-Wei. Due to the time constraints, we will conclude the meeting now. Thank you 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, and happy Lunar New Year.