Good afternoon, everyone. Welcome to Realtek 2022 First Quarter Earnings Call. This call will be chaired by Realtek spokesman, Yee-Wei Huang. This presentation will be available on the company website before 6 P.M. today. At the beginning, our spokesman will report our first 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. Note that a portion of what is presented in this call contains forward-looking statements. Investors are cautioned that forward-looking statements involve risks and uncertainties. The actual results may differ materially from the results forecasted or implied in such statements. That investors should not place undue reliance on such statements.
Now, I'll pass this call to our spokesman, Yee- Wei.
Thank you. Good afternoon, ladies and gentlemen on the line. You are currently on the first quarter 2022 webcast earnings release hosted by Realtek Semiconductor. Now, let's go through first quarter 2022 operational results. First quarter revenue was TWD 29.76 billion, and 8.7% QOQ growth, and a 27.5% increase compared to the same period last year, achieving another historic high. The growth in the first quarter came mainly from communications network and commercial applications, the strength of which has compensated for the weakness in certain consumer applications. This trend is expected to continue in the second quarter. Further, note that U.S. dollar appreciated 3.6% against Taiwan dollar in the first quarter compared to the fourth quarter last year. The stronger U.S. dollar also contributed to part of the revenue growth.
First quarter gross margin was 52.2%, slightly lower compared to 52.9% in fourth quarter 2021. The small change reflects normal fluctuations. There's no change in company's product mix. Q1 operating expense was TWD 10.23 billion or 34.4% of revenue. A 1.4 percentage point drop compared to the previous quarter. Faced with prolonged shortage of talent in the semiconductor industry, both local and foreign companies are offering aggressive salaries to attract talent. Realtek cannot afford to fall behind. We are offering highly competitive compensation package in recruiting and retention of talents. Further, Realtek continues to invest in innovative R&D and expand our supplier base. We do not expect OpEx ratio to significantly reduce anytime soon. Nevertheless, we still strive to leverage our economy of scale to lower our OpEx ratio as we grow.
Q1 operating profit was TWD 5.3 billion or 17.8% of revenue. Lower OpEx ratio is the main reason to a higher operating profit. On non-op income, first quarter was TWD 101 million. A lower valuation of financial assets gives rise to a lower non-op income. This leads to the first quarter net profit of TWD 5.19 billion or 17.4% of revenue. EPS as a result was TWD 10.15, an increase from TWD 9.02 in the first quarter last year. Regarding inventory, Q1 inventory turnover days was at 114 days. This is a five-day decrease from 119 days in Q4, but still at a high level.
This reflects a continuing challenge of supply imbalance in the supply chain. At Realtek, over 50% of the inventory are work in progress, unfinished goods. Although the inventory turnover days may not drop quickly, we are certain that inventory will be consumed in due time. We also have the first quarter balance sheet and cash flow statement for your reference at your convenience. This concludes Realtek's first quarter 2022 financial report. Forward looking, the near-term overall market demand is solid. We are cautiously optimistic about the second quarter operations. However, it is still necessary to pay close attention to the impact of Russian-Ukrainian War, the pandemic and inflation on the end demand, as well as the production capacity of semiconductor supply chain. As before, we will review the top product lines at Realtek.
First, we observed that PC versus non-PC revenue split remains about 35%-65% in the first quarter, same as the last quarter. On Ethernet, this is a fundamental and essential technology for wired local area network. Requirements for communications network applications show no sign of slowing down. Besides PC, we observe continuous spec upgrade to 2.5G Ethernet in networking devices such as cable modem, AP router, switch, phone and et cetera. For switch, we expect strong growth in 2022, benefiting both in quantity increase and product mix shift to managed switches and multi-gig switches. On Wi-Fi, strong spec upgrade to Wi-Fi 6 for PC, router, broadband, TV and OTT boxes should be sustainable. For consumer markets, we haven't seen recovery since fourth quarter last year.
We need to pay close attention to the impact by war, lockdowns in China and inflation. On PC audio codec, strength in the commercial PC sufficiently compensates weakness in the consumer segment. Some OEMs are expressing concern about the prolonged weakness in consumer and educational markets, while others expecting the strength in the commercial segment to overcome said weakness. On TV, we still expect flat or slight drop in worldwide TAM this year. Temporary strength may be attributed to the ongoing decreasing panel price. Further, future growth opportunity may be in gaming PC. On Bluetooth, end-product demands, especially consumer-oriented ones, is expected to be at about the same level of 2021. Long-term outlook, nonetheless, remains positive due to new spec features and new applications.
Thank you, Yee-Wei. Now we are entering the Q&A session. Please type your questions in the box in the lower right corner on the screen. We will reply accordingly. Now, first question is from Randy, Credit Suisse. He would like to ask first quarter 2022 business trends and outlook for growth into the coming quarters. What areas drove the upside to your sales outlook in first quarter, and how do you see sequential growth continuing into the next couple quarters?
Yes. The strong first quarter results can be attributed to two things. First is the certain order holdback in Q4. Second, and more importantly, is the continuing strength in Ethernet switch, PC audio codec. This reveals strength in communications network and commercial segments, including commercial PCs. The strength is more than sufficient to compensate for the weakness seen in some consumer and educational segments. We expect such trends to continue in the second quarter. Nevertheless, we still need to pay close attention to the impact by the Russo-Ukrainian War, the current lockdowns in China due to their zero-COVID policy and inflation on the end demands, as well as any changes in production capacity of the semiconductor supply chain.
Followed by the first question. Randy would like to ask, what changes have you seen in demand from the COVID-19 lockdowns in China and also Ukraine-Russia conflict? Have the lockdowns impacted downstream production, which delays your shipments?
Well, first, here are what we know about lockdowns in Shanghai, the most populated city in China. The logistics is badly hampered, resulting in longer routing distance and time to transport goods. Although moving of goods is not at a complete stoppage. Production of goods is resuming with 666 key companies, including TSMC and ASE, you know, restarting their operation on April 19, and more may follow. We have not seen immediate impact on the demand side. Nonetheless, things may turn ugly if the lockdown persists. Based on past experiences, lockdowns generally impact mid- and long-term supply, but not necessarily demand. Both sea and land shipments have been badly impacted by COVID-19 before the ongoing lockdowns of 45 cities in China. The added impact may not be immediately observable.
If prolonged, nevertheless, the added impact could add to the problem, causing further delay in sea and land shipments. The impact by Ukraine-Russia war has no precedent, although we have seen rising crude oil prices that may result in higher energy costs for both industry and general household. That is, it may impact both supply and demand. For example, we have heard long-haul container ships are traveling at a slower speed to optimize fuel consumption. Overall, nonetheless, congested ports presents the biggest bottleneck, causing shipment delay currently as explained above.
Next question is from Daniel Yen, Morgan Stanley, regarding OpEx. What is our OpEx budget for 2022?
Engineering expenses constitute the largest portion of OpEx. Realtek is committed to budgeting adequate investment for attracting best talent to perform innovative engineering R&D while expanding our supply base. To this end, we expect OpEx amount will grow when the company scales up. Nevertheless, we strive to leverage our economy of scale to lower our OpEx ratio as we grow. As previously highlighted, we do not expect OpEx ratio to reduce significantly anytime soon as we fight the industry to attract and retain top talents.
Next one. Rick from Daiwa would like to ask, how's the supply-demand gap right now for Realtek and compared to three months ago? When Realtek expects the supply tightness will be largely eased?
We did hear that some fabs have recently added some incremental capacity. The quantity is too limited to relieve the supply constraints while the demand overall remains strong. For back-end assembly and test, substrate shortage remains a critical bottleneck. To the best we can see at this juncture, the supply constraints are not expected to go away anytime soon.
Next question is from Bruce Lu. Related to pricing environment we are facing, the question is, what's the pricing environment in the remaining 2022 and 2023? Are we expecting any further price hike for certain products that are still in shortage, such as Wi-Fi 6? Also, are we expecting any price hikes from foundry in the remaining 2022?
Well, Bruce, the pressure for further price increase by foundries still exists. When it does happen, nonetheless, we expect it to be modest compared to 2021 in terms of both scale and scope, therefore less impact. Realtek takes a passive role in price increase. We'll handle price increase case by case this year, Wi-Fi 6 or otherwise, if and when it happens.
Next question is from Aaron Jeng. He would like to get an update on current inventory cycle and how would any demand noises impact your business? Any difference versus last week, last quarter?
A good portion of inventory at Realtek, more than 50% actually, is with, including memory, known-good die, KGD. For finished goods, the inventory is higher for consumer-oriented products. We have adjusted production for products with high inventory. Further, we are working with customers to consume the inventory where applicable. We are confident to reduce inventory slowly but surely.
Next question is from William, JP Morgan. If market demand is weaker than expected, market share versus gross margin, which one would the company focus more on?
Well, the fact is that Realtek, in our, you know, by now 35 years of history, we have faced market up and down many times. We know how to balance market share versus gross margin, and we never stop optimizing our product cost structure. We will handle this.
Next question. Kevin from Mizuho would like to ask that PC market and consumer market are relatively weak. Have we sensed the orders slow down from the customers in those segments?
Currently, the softness in the consumer PCs has been overshadowed by the strength on the commercial side. Note that the stronger the PC makers in the consumer segment, the more conservative in their tone when forecasting the 2022 PC market. We continue to do 2 volume forecast updates every month. Up to now, the orders are holding. For China consumer market, it has been weak since fourth quarter 2021 and it is still weak.
Next question is from George, KGI. Please update on our recent Wi-Fi 6 business status and the price gap among Wi-Fi 4, 5, and 6, as well as Wi-Fi 7 development progress?
Currently, Wi-Fi 6 clearly is a priority at this time. We will continue to enhance the feature and performance of our Wi-Fi 6 while optimizing its cost structure. Realtek 6E, Wi-Fi 6E has been at customer sites for their product development since last quarter, with MP shipment expected in the second half this year. We do not expect fast ramp-up of 6E, as there are currently only 17 countries that have adopted Wi-Fi 6E and opened the 6 GHz spectrum for it. China, Taiwan, and most of the Asian countries have not adopted Wi-Fi 6E. Further, PCs and phones, these are endpoint devices, but not routers, are soon to be the first applications to adopt Wi-Fi 6E. All these will limit the value of Wi-Fi 6E in the near term. Wi-Fi 7 development is progressing as planned.
We are pacing our product development to participate in the first Wi-Fi 7 interoperability plus test scheduled this fall. Regarding price gap among Wi-Fi 4, 5, and 6, it stays at about the same level as last quarter, around 1% to 3% to 4.5%. Wi-Fi 6E may add another 30% price premium over Wi-Fi 6.
Followed by previous question. Any challenge you have met in the migration to FinFET process? How will you manage the foundry supply of 6nm nodes as it is in supply constraint as well?
Yeah. Well, more new fabs are built for advanced nodes, meaning 14 nano or smaller than the mature ones. We expect the industry will progress in technology advancement and migration as always. Products using 14, 12 today are expected to move to smaller geometry, such as 7 and 5 in time, when Wi-Fi 7 is ready for volume production, likely in 2024. For power consumption and long-term planning with all factors considered, we are better off to plan Wi-Fi 7 in FinFET.
Next question from George, KGI. Can management provide some outlook of the bidding market and 5G infrastructure? Is it impacted by COVID-19 lockdown in China?
Well, the infrastructure build-up seems to be unaffected. As previously explained, we have not seen impact on the demand side at this point. The market term of telco tender projects stay at about the same level as last year. Nevertheless, we need to pay close attention to the impact on demand by lockdowns if they drag on.
Next question from Credit Suisse, Randy. What are you seeing for upgrade 10G PON managed switch mesh router?
10G PON managed switch mesh router. These are all communications networking devices that have been in strong demand since the pandemic, as they each play an essential role in network infrastructure that keep people and devices stay connected. The more people and endpoint devices to stay connected, the higher demand in the network speed, manageability, coverage, and flexibility. To support 10G PON and 5G, new managed switches are upgraded to have more multi-gig ports as opposed to 10/100 and gigabit Ethernet ports. Mesh routers are practical solutions to eliminate Wi-Fi dead spots. To ensure best performance, some mesh routers are upgraded to have tri-band, with the third band dedicated for the inter-router backbone traffic.
A follow-up question from Randy: Could you discuss what you are seeing on the retail router gateway market, both in overseas and China market? Are you seeing change in pace of upgrades to mesh router, managed switch or Wi-Fi 6? Could that offset the weakness or the upgrade are also slowing down?
Well, first, an important thing to note, if you haven't been aware of, is that in China, as well as in the global market, retail routers are gradually overtaken by telco and broadband operators, who now also offers routers to their subscribers. At the same time, all routers are going through generation, meaning spec upgrade. For example, from AC1200 that's using Wi-Fi 5 to AX1500, 1800. These are using Wi-Fi 6 and even higher specs. The same goes to the mesh routers and routers with manageability for small and medium business, which are also gradually replaced by operators offerings. Gateway and managed switch are sold through telco tender projects. The demand for devices mentioned above remains strong in the first quarter, and the momentum is expected to continue in the coming quarters.
Next, also question from Randy: Have you seen any stabilization or recovery in the TV market?
Overall, we still expect TV worldwide TAM to be flat or even drop slightly this year. Some of the temporary strength we observed recently most likely is attributed to the ongoing decrease in panel prices, which is expected to stop at some point. Future growth opportunity may be in gaming TV. That is, TV with higher frame rate.
Next question is related to the Auto Ethernet. Could you give us some colors on it, which including revenue contribution in 2022, competition landscape change and technology trends?
Automotive Ethernet absorption is clearly picking up momentum and accelerating. We expect Realtek Auto Ethernet 2022 growth to again significantly overpace corporate average. The competition is still among a handful of strong players, including, other than Realtek, Broadcom, Marvell. The trend in the coming years will move at equal intensity at two fronts. First, higher speed, safety, security, and also very high speed interfaces. Second, lower cost and optimized features for broad cost-sensitive adoption. The two is opposite in require engineering this innovation, but they will proceed in parallel.
A follow-up question on auto market. Could you share opportunities and progress for other products for Realtek?
Indeed, car companies are, you know, expressing lots of interest in Realtek other than automotive Ethernet. To name a couple examples, Wi-Fi, Bluetooth, you know, come to mind. In fact, even before, even beyond these two, there are a few more we are working with automakers. We will share more progress in time.
Next question is related to USB4. What's our strategy for USB4 hub device product development? Any ambition to enter high-speed interface market given ample IP portfolio for DP, HDMI, PCIe, and USB?
Well, interestingly, USB4 is the lowest speed among the few standard you mentioned. USB4 runs top theoretical speed at 40 Gbps. HDMI 2.1 at 48 Gbps. DisplayPort 2.0 runs at 80 Gbps. PCIe 5.0 runs at 504 Gbps. These are all very high interface and Realtek currently have focus either on in the of development. These products are common purpose technology. Realtek has worked on high for many years and applied the attention. We will keep up the pace.
Next question. Could you share the near-term demand for TWS market and new product development?
On TWS, Realtek will continue to focus on mid and high-end customer with enhanced features. Other than active noise cancellation, ANC, we are currently leading in introducing solutions to support LE Audio, you know, featuring the very efficient LC3 codec, also very innovative multipath stream and broadcast features. Overall, although we do not see strong growth of the TWS market this year, we believe there's still plenty of opportunity to expect in this market segment.
Next question. Does Realtek consider to spin off any business and make it listed? Why or why not?
Well, we continuously review all business. There's a possibility as the company scales, including spin off as well as M&A. These are all possibilities and when we have a more concrete development, we will share with everyone.
Next question. Realtek invested in fab transfers and diversified foundry supply last year. Could you provide some colors on the current progress?
Right. Up to now, no. In fact, it's a continuous ongoing effort. We have already qualified several new foundry partners and also new fabs with existing foundry partners. They are at different stages of initial ramp up. Overall contribution to the capacity that Realtek needs is still low. Therefore, the allocation among different foundry partners has not changed much at this point.
Next question is from Schroders. How did exchange rate impact the gross margin in first quarter 2022?
Exchange rate, I do not believe. The exchange rate. That's what I thought. No. It wouldn't have any impact. We buy and sell both in U.S. dollar. In that sense, you don't need to factor that in this gross margin consideration.
Next question. Spokesman just mentioned that the commercial PC outperformed consumer PC. Could you share the dollar content difference between the commercial PC and consumer educational one?
We do not have the breakdown on hand. Yeah. Generally, currently, it really, the consumer one is a much smaller portion, but we do not have the quantitative split on hand.
Next one is from HSBC Jacob. Could you share the company's view on the first half and second half seasonality? Could we still expect a better performance in the second half than the first half?
As we stand here today, although we have said, it may be too soon to comment on the second half, but to the best that we can see now, I would say we are optimistic or at least cautiously optimistic that second half will be at least as good as first half or better.
Next question. Management just mentioned that we are facing competition in recruiting and retaining talent. Could you share the current employee turnover rate and strategies company has to retain the talent?
Overall, turnover rate actually is pretty low. At least, I can share with everyone in the science park where we're situated, I believe the turnover rate is you know, 10% or higher. Realtek turnover rate, at least I can share with everyone, is much lower than that. Other than good package, of course, many of you probably have heard, you know, people leave their jobs, you know, for all the reasons. Oftentimes, salary or pay usually is not the top reason. Yes, we do need a competitive package, but to really keep the talent, we need to make them feel they have future, they can do the things they like, and, you know, they feel they have a platform they can really show off their talent.
You know, that's all the many angles we need to provide the best possible working environment, so they feel they are needed and they can make a difference in their work. That's how we are doing continuously.
Next question is from Daniel, Morgan Stanley. How do you see the market share gain opportunities in 2022? Some U.S. peers are still allocating more capacity to auto. Would like to know the room for you to take more shares.
We believe so. There are some of our international competitors, historically, they are stronger in the mid, high-end or super high-end segment. Realtek more on mid, mainstream and low-end. With the shortage, Realtek actually find our way in many of the mid, high-end design-in that in the past we didn't really be too successful there. This time, we actually gained quite a bit of design-in in that regards. Yes, as some peers move their focus to one area, the void they open up present the opportunity for Realtek.
Next question is from Bruce, Goldman Sachs. Who are the key competitor for our products such as Wi-Fi, Ethernet, and switch? Are we seeing any new competitor or stronger competition from China?
Last point about competition in China. Of course, there's always competition in the largest market, you know, globally. But oftentimes, they are more for the market area Realtek plays in. When we do find competition in China, oftentimes they are more on the low-end, entry-level, basic feature type of competition. Currently, Realtek, we actually our product mix has shifted. We do pay close attention. You know, it's not that we completely ignore some of the mid, low-end market. We do pay attention to that, but we pay even more attention to the mid, high-end market. In general, different segment, we have different competitor. Wi-Fi, even Wi-Fi, different applications. In PC, we face Intel.
In some other area, we face MediaTek, Broadcom, and Qualcomm. You know? This Ethernet really, there's much less competition there. Company like Aquantia, you know, they are competitor in switch. Yeah, different area, oftentimes we will see different competitors.
Thank you. Next question is from Sky Chan from Nomura. What is the initial business outlook for 2023?
We just commented about the second half and so for 2023, first I would say we believe it's still going to be a growth year. That probably is the most I can comment at this time. We still believe for Realtek it will be a growth year, and I probably wouldn't be able to be more specific than that.
Next question. Could you provide the guidance of gross margin for longer term, say 2023 and beyond?
As we have said a few times in the past, and of course our gross margin, we believe it will go up and down. The level we stay at this point is the level we have been here for by now over a year or exactly a year or over a year now for four or five quarters now. In general, we believe that this is the level we will try to maintain. It will go up and down, but you probably will find that roughly in this level.
Thank you, Yee-Wei. Due to the time constraint, 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 P.M. Thank you and have a good afternoon.