Good afternoon, everyone. Welcome to Realtek 2023 second quarter earnings call. This call is chaired by Realtek spokesman, Yee-Wei Fang. 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. 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 presentation anytime. Note that portions of what's 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 will pass the call to our spokesman, Yee-Wei.
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. Let us go through the second quarter, operations results. Q2 revenue was NTD 26.29 billion, a 34% QoQ 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 growth 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 NTD 8.87 billion, or 33.8% of revenue. OPEX ratio dropped 2.1 percentage point, this meeting expectation. Q2 operating profit was NTD 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 NTD 627 million, an increase from last quarter, thanks to higher interest income and foreign exchange gain. Q2 net profit was NTD 26.1 billion, or 9.9% of revenue, a 0.8 percentage point increase quarter-over-quarter. Net Q2 EPS was NTD 5.08. Regarding inventory, Q2 inventory turnover days were at 133 days, a noticeable decrease from the 210 days last quarter.
In terms of $ amount, Q2 inventory decreased by 13% compared to the last quarter. We expect inventory days to continue to fall in the third quarter. We also have second quarter balance sheet and cash flow statement for your reference at your convenience. This concludes Realtek's second quarter financial report. 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 operation. Now, let's review the top product lines at Realtek. First, we estimate that PC vs. non-PC revenue to be approximately at 32%-68% in the second quarter. This represents the second consecutive quarter where sales tilted toward PC-related product at Realtek. This speaks to the restocking of the PC market and the slower than expected recovery of other markets, communication networks 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 cost. Nevertheless, the overall PC market is softer than expected, resulting in stagnant adoption of 2.5 Gb 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 build of PC motherboard featuring 5 Gb Ethernet. Outside the PC domain, the Ethernet demand for CE and networking network remained slow in second quarter. For long term, Multi-Gb solutions will drive the growth of Ethernet business for both PC and non-PC applications.
Now, switch business is, has a strong correlation with the strength of the global communication network infrastructure build up, 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 will regain its strength in 2024. When the strength returns, Multi-Gb switches with 2.5 Gb or 10 Gb, or 10 Gb PHY 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, enable indispensable mass connectivity between edge AI devices and the cloud servers.
We look at the Wi-Fi, which see growth in both consumer and PC segments. For consumer, 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 spec 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 process is still ongoing as we speak. Realtek first Wi-Fi 7 will target at high-end routers and PCs. On codec, although we saw PC-related rush order in second quarter, the 2023 full year PC forecast remains soft.
By first quarter end, the consensus appeared to be a 10% year-over-year drop in total PC, notebook, Chromebook shipment in 2023. The new consensus 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, Realtek continue outside PCs, Realtek consumer audio codec continues to find success in gaming and mobile phone markets. Further, Realtek 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 195 million-200 million sets 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. Realtek TV is staying the course to beat the market performance through share gain.
Thank you, Yee-Wei. 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. 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? A strong recovery already. Which application do you expect to lead the growth, and do you see any area now correcting?
Well, after a notable second quarter, 32%, 34% QoQ 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 chug 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 wild card 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.
The second question is from Daniel, Morgan Stanley. Is there any preliminary outlook for 2024 that you can share?
Yeah. Every customer we talk to is expecting their business to return to growth in 2024. We share the conviction. The question is, when in 2024 to 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 port 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. There's little doubt that 2024 and beyond will bring enormous opportunities to Realtek.
Next question is from Sunny, UBS. How should we think about the structure gross margin versus, pre-COVID label? From quality perspective, in which quarter would you expect the gross margin to stabilize with, inventory write-down impact moderating?
Yes, indeed. One major factor depressing Realtek growth margin since second half 2022, is the accounting loss from slow-moving inventory. Although this factor has been impacting Realtek growth margin since second half 2022, due to the fear of supply shortage and poor order visibility, compounded by uncertain global economy, well, its effect is expected to subside after third quarter as we regain inventory control. In mid to long term, we still move toward a product mix with higher value and better growth margin.
Next question is from William, JP Morgan, regarding the inventory. Please update the inventory situation by your major products or end applications.
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 one 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.
Next question is from Randy, Credit Suisse. Can you discuss your expense growth in the second half or expected OpEx as a % of revenue, if the revenue growth slows down?
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 NTD 30.5 billion, to a quarterly low of NTD 19.6 billion. Nevertheless, our OpEx ratio fluctuated within a small interval between 33.8%-35.9% in the same period. In the short term, it is most likely that the OpEx ratio will stay within the small interval seen in the past 6 quarters. In the long term, as company scales up, we're still striving to lower our OpEx ratio.
The next question is from Kevin, Mizuho. What is the current order outlook for PC-related business in third quarter?
Yeah, 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.
Next question is about the PC outlook in 2024. Microsoft may launch Win 12 in 2024. What's your initial assessment about the replacement opportunities and the PC demand next year?
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 sets 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 Win, than Windows 12 release. Well, the Win 12, which nevertheless may bring additional incentive for PC notebook refresh. All PC market players are paying close attention to the development.
Next question is from Bruce, Goldman Sachs. Would 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?
Yes. Telco tender project delays 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, it may take another 3-5 months to reach a meaningful shipment. It is worth noting that the infrastructure build-up is actively pursued by governments around the world. Case in point, U.S. has announced to spend $42 billion to make internet access universal by 2030. Such infrastructure expansion projects always provide growth opportunity to Realtek.
Next question is from Rick Daiwa. For existing products, are they facing pricing pressure? How much of price erosion for the existing product this year, and any potential threats from the competition of ROHM?
We prefer not singling out particular competitions in our comments. Price pressure is all in a day's work in our industry. It comes from all directions, from suppliers, customers, and competitions. 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 discreetly to seek win-win. Overall, we see the pricing to be under control. More importantly, we are developing cheap solutions with better cost structure and more desirable features to justify our product value.
Next question is from Bruce, Goldman Sachs. Given the overall demand slowdown, how's the progress on spec migration, especially for Wi-Fi markets? Is the migration on track or slower than we expected?
Spec upgrades for connectivity solutions never stop. The 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 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 due to its many desirable features. Perhaps the most exciting one is Multi-Link Operation, where several frequency across different bands are combined into a single connection. This provides a highly efficient use of the available frequency spectrum. Be practical, nevertheless.
We believe a ramp of Wi-Fi 7 may start in 2024 at the earliest, and the pace may be modest. Note that many countries, including China and most in Southeast Asia, Middle East, and Africa, still have not approved the 6 GHz band for Wi-Fi usage.
Next question is on Wi-Fi by Lucas, KGI. What are the anticipated penetration rates for Wi-Fi 6 and Wi-Fi 6E in PC, notebooks, and routers in 2024? Is there any potential for accelerated penetrations of Wi-Fi 6, Wi-Fi 6E in other applications?
As the market is anticipating Wi-Fi 7, Wi-Fi 6, 6E in PC and routers may gain another 5%-10% penetration at most before saturation. As a rule of thumb, Wi-Fi 6, 6E are suitable for applications that demand high throughput, low latency, and/ or low mask, or, and, or, mass connectivity. Nevertheless, we envision Wi-Fi 6, 6E may become the spec of choice for mainstream market in time, leaving Wi-Fi 4 for some basic IoT applications.
Next question is from Aaron Nomura. What's the current market share of your auto Ethernet products, and what's your view on competitions? Do you see it rising from China? What's your product roadmap, and how big is the TAM?
We do not comment on market share as a matter of principle. There are only a handful of automotive Ethernet solution providers. Besides Realtek, Marvell and Broadcom are the two other marquees in the field of automotive Ethernet. There are China players vying for the sockets. While competitions are good, they keep technology moving forward. To estimate the TAM for automotive Ethernet, we'll consider the following factors. One is total annual light vehicle sales, which is expected to be between 80 million and 90 million per year in the next few years. Penetration rate of Ethernet in light vehicles. By the end of 2023, International Energy Agency projects some 14 million EVs will be sold this year, which represents 17% EV penetration. By 2030, the EV penetration could reach 35%.
All EVs adopt automotive Ethernet, to the best of our knowledge, while some petroleum cars, especially those with L1 or higher level of autonomous driving for sure, adopt automotive Ethernet. Overall, we observe more than half of the 2024, 2025 car models come with automotive Ethernet. 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 roadmap, we are developing solutions to address the industry's needs for higher bandwidth performance, lower power, lower latency, more versatile interface, and, and higher safety and security.
Next question is from Daniel, Morgan Stanley. Does Realtek have any new products or technology that is likely to be mid to long-term growth drivers?
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 5G networks that provide a wide area network infrastructure, while Realtek solutions offer local and personal area network, completed with an audio-video based, most natural man-machine interface. To this end, Realtek seeks technologies that may mass-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, on top of the market, besides on top of the, besides the market we serve today, we target to expand the market to, you know, auto, healthcare, and industry segments.
This will support the long-term growth of the company as well.
Next question is from Rick, Daiwa . Do we have any new AI-related projects going on?
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 continues 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.
Next question is from Sunny, UBS. What are the drivers for managed switches and 2.5 Gb Ethernet? For switches, what's the split of the managed switches versus unmanaged switches last year, and how meaningful would you expect the managed switches to account for in 2-3 years? What's the latest progress of your share gain in managed switches?
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 connectivity. 10G-PON, Wi-Fi 7 are two examples of enabling technology to facilitate high-speed network connectivity. Working in tandem are Multi-Gb switches equipped with 2.5 Gb Ethernet ports. Managed switch let users adjust each port on the switch to any setting, enabling them to be managed, 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 operation, and by IoT devices in a smart home network. Realtek today ships many more unmanaged switch than managed switch. We have seen, nonetheless, managed switch deliver higher growth, both in quantity and revenue than managed switch as we speak. We expect this trend to continue.
Okay. Next question is regarding our Bluetooth business, from Lucas, KGI. What is the outlook for Bluetooth segments in 2023 and 2024, 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?
Well, actually, Realtek Bluetooth solution finds 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 Auracast.
Next question is from Jason, CLSA. Hearing that TWS demand is improving, does Realtek benefit from this recovery?
Well, TWS market, with the highest shipping, 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 LE Audio and AI noise reduction that is tailored for the 1.5 billion people with mild to moderate hearing loss.
Next question is from Randy, Credit Suisse. could you share or discuss how Realtek's positions versus an overseas competitor, Cirrus Logic, which plans potential to gain share as audio codecs, supporting SoundWire, are adopted? Does the standard change also have any meaningful dollar content increase or ability to drive more growth for the audio codec segment?
Yeah, the new spec commands a higher ASP, which helps the top-line growth. Realtek, we not only for the longest time, is a leader in the HD Audio codec. Realtek SoundWire solution is already found in most PC reference design as a front runner. While we acknowledge ATI Series logic, they are also players in SoundWire. Realtek, we are confident to hold on to our audio codec supremacy in SoundWire codec.
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 relatively, to consumer or IT segment?
Okay. Realtek is moving steadily into the health wellness market. Our Wi-Fi, Bluetooth, IP cam, monitor scaler solutions are in different stages of entering health wellness market. A recent example is the OTC hearing aid, TWS, for mild to moderate hearing loss. The total market opportunities are not small by any measure.
Next question is from Daniel, Morgan Stanley. How's the current pricing for TV SoC, and your view on the trend for 2023 onwards?
Yeah, yeah. Short-term price pressure aside, most Realtek products are seeing ASP increase from one generation to the next. As customers demand higher specs and more integration, we see no exception for TV SoC in this case.
Okay. Our next question is from Tiffany Yeh, from Morgan Stanley, too. Could you provide a breakdown ASP of Wi-Fi 4, 5, 6, and 7?
Yeah. Okay. Roughly what we see in second quarter, the ratio comes to about 1 to 3, to 4.5, to 8. What you are seeing is price, this gap, shrink a little bit.
Okay, there's a couple questions from Capital Investments. First, could you clarify the impact of inventory provision on second quarter 2023 gross margin?
It is a visible impact there. Let me stay, stay with that, that the impact of this inventory provision on the second quarter margin is quite visible.
Okay. The second questions is, could you update the Chinese telco bit in streaming trend, for example, on the set-top box, the routers, and the PON?
Okay. Well, briefly, it's slow, you know. You mentioned about OTT box. In China, you may hear roughly 70 million, as you mentioned, but when we look into it, the actual deployment may be only 50 million or lower. That's the difficult part to really, you know, 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 total bidding volume, maybe still around 100 million, but if you look deep into it, the actual deployment will be much, much smaller than that, and same for the router.
Okay. The next question is from Ethan Young, TransGlobe Life. During the first quarter earnings, the management commented that reducing the inventory to reach a 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 date?
Right. You know, as the, the market visibility is low, uncertainty is high, and everybody still, you know, sometimes they lose sleep when they recall the product shortage, you know, the, the nightmare they had before. Oftentimes, many factors come into play in inventory. At Realtek, we would like to work together, you know, not to shoulder all the burden by ourselves. We're, we're working very closely with our, this, both, supplier and customers, to manage this. Now, ideally, I think the first goal is still looking at maybe less than a 100-day turnover, turnover date to be 100, not a hard and fast goal, but it will be a target to start.
Okay. The next question is from Freddy Chain. Does the company have any plan to expand the ASIC business?
Quite a while back, I heard similar question before, my answer to you is application-specific IC, arguably, all Realtek solution are application-specific IC. What you are asking, I believe, actually is a little bit tailored for particular customer. I, I believe you are asking ASIC for different customers, customized ASIC, I believe that's what you are asking. To that end, we are very open to that. When we develop ASIC, you know, target for a particular application, we always keep in mind, customers want differentiation. Customer A and customer B, they all want Wi-Fi 7, let's say, but they all want to use it maybe in a slightly different way to claim their uniqueness. In that sense, we always work with customer to meet their requirement, even though we are providing standard product. Short answer, yes.
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. Have a good afternoon.