Good afternoon, everyone. Welcome to Realtek's 2020 Second Quarter Earnings Call. This call will be chaired by Realtek spokesman, Yee-Wei Huang. The presentation will be available on the company website before 6:00 P.M. today. At the beginning, our spokesman will report our second quarter results and give the 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 question accordingly. During the call, you can browse through the page of the presentation anytime. Now, I will pass this call to our spokesman, Yee-Wei.
Good afternoon. This is Yee-Wei Huang of Realtek. Now, ladies and gentlemen, you are listening to the Q2 2020 Webcast Earnings Release by Realtek. As the fight against COVID-19 continues to be a global effort, Realtek will stay with webcast for our quarterly earnings release. At Realtek, our business operations are normal, while the company is vigilant about face mask wearing and safe social distancing. Now, let me turn your attention to Realtek's Q2 operational results. Q2 revenue was TWD 17.3 billion, an 8.9% QoQ growth, and a 14.2% increase compared to the same period in 2019. The result clearly reveals that Realtek business momentum did not slow down in the face of COVID-19. This can be attributed to the demands for more and better connectivity solutions from work from home.
It is worth noting that products revolving around PC, notebook, Chromebook, their peripherals, and devices connecting to them are the primary beneficiaries from work from home. This gives rise to a PC and non-PC split, shifting from 27%-73% in Q1, to 34%-66% in Q2. Q2 gross margin was 44.8%, compared with 42.2% in Q1 and 44.3% in Q2 2019. The gross margin is on the high side of our historical range. This is due to product mix favoring products with high gross margin. Q2 operating expense was TWD 5.79 billion, or 33.4% of revenue. This is a slight QoQ increase of 0.3 percentage point, YoY increase of 0.1 percentage point. Such result is within company's expectation. Q2 operating margin was TWD 2.0 billion or 11.4% of the revenue. A 2.3 percentage point increase QoQ, 0.4 percentage point increase YoY.
Better operating margin is a result of higher gross margin and improved R&D operational leverage. Q2 non-op was TWD 191 million. A smaller non-op compared to TWD 287 million in Q1 and TWD 290 million in Q2 2019. Smaller non-op was due to unfavorable foreign exchange rate for the TWD. Q2 net profit was TWD 2 billion and 11.7% of revenue. This is a 1.5 percentage point increase QoQ, but a 0.5 percentage point decrease YoY. Q2 EPS as a result was TWD 3.97, better than TWD 3.21 in Q1 and TWD 3.63 in Q2 2019. Regarding inventory, Q2 inventory turnover days were at 89 days, compared to 80 days in Q1. The increase was mainly due to increasing uncertainty in the market, and Realtek's careful planning to have flexibility to cope with the uncertainty in face of the tightness of the supply chain.
Note that the unaudited consolidated balance sheet and cash flow statement are appended in the presentation for your reference. This concludes Realtek Q2 financial report. Forward-looking, after a solid Q2, we are cautiously optimistic about Q3 as the momentum of customer demands for various Realtek products is expected to continue in the third quarter. We must pay close attention to the changes in COVID-19 pandemic, as well as international tension and their impact on the macro economy and the end market. Let's run down the top five product lines at Realtek to help you with more insight of Realtek's performance. First, Wi-Fi overall performed above corporate average in Q2. It did particularly well across PC, AP router, and broadband set-top box segments. Not so well in consumer electronics and IoT. For Q3, we see steady demand increase in all segments.
Wi-Fi will continue to be a growth driver for Realtek in 2021. Ethernet demand was higher than expectation in Q2 to facilitate better work from home experiences. This includes Ethernet for PC, notebook, as well as dongles and docking devices. We expect the demand momentum to continue in Q3. Further out, we are seeing the steady picking up of 2.5 Gb per second Ethernet, both in PC and broadband related applications in 2021. Third, switch. Switch performed strongly in Q2 in both Gigabit Ethernet switches and unmanaged switches for Realtek. We expect steady growth of switch product lines in Q3 and even in 2021, thanks to robust demand for more connectivity, faster connectivity, and better manageability. Fourth, TV. TV performed below corporate average in Q2 due to the impact of COVID-19 on non-essential consumer products.
Nonetheless, we are seeing a clear rebound in both TV supply and demand in Q3, especially in North America. For the 2020 full year, worldwide TV TAM is still expected to drop mildly. Realtek 2020 full year TV shipment is expected to grow healthily YoY through share gain. Last but not least, Bluetooth also performed below expectation in Q2, especially in TWS, due to both its labor intensive nature in manufacturing and COVID-19 impact on non-essential consumer products. Consistent with what we are seeing in TV, we expect the demand for consumer-oriented Bluetooth products to rebound in second half of this year. We expect Bluetooth to be a 2021 growth driver with technology migrations, including ANC and Bluetooth, and BLE, low energy Bluetooth audio and more end applications. This sum up my operation summary.
Thank you, Yee-Wei. Now, we are entering the Q&A session. Please type your questions in the box at the lower right corner on the screen. We will reply accordingly. Now, the first question is from Daniel Yen, Morgan Stanley. There's a supply chain tightness. Does this mean the pricing erosion for Realtek's products, for example, the Wi-Fi and TV SoC, will be less into second half 2020? The second question is: Which product drove the inventory days higher in Q2? When will this come down to the healthy level? Thank you.
Okay. The first question about supply chain tightness vis-à-vis pricing erosion of Realtek products. My understanding, these two really have no correlation or very, very weak correlation. Supply chain tightness, it boils down to either you get the capacity you need, or you don't. It rarely, in our experience, you can come in and throw in money and say, "I pay you this much more. Give me the capacity." In most cases, it doesn't work that way. The price erosion really has to do with market-oriented economy and competition. My observation is a very weak correlation, if any there. Regarding the inventory in Q2, which one tends to be higher, and when will they come down? The one that's higher in Q2, what we see is more so-called non-essential consumer products. Their forecast really is, at times, erratic.
We expect this challenge will pretty much continue until there's a more stable outlook for the pandemics.
Okay, thank you. The next question is raised by Aaron Jeng, Nomura. Could you give us an update regarding your ANC TWS products, including the ramping up schedule, percentage of revenue contribution by the year-end, and the competition landscape changes?
Well, the entry barrier of ANC TWS product is much higher than that of the previous generation product. Due to the impact of COVID-19, the rollout of the ANC product is slower than expected. We expect a smaller number of competitors in both product and IC component level moving forward. For Realtek, the leading ANC customers are already in mass production shipment in the first half this year. Now we are seeing more customers getting to MP stage in the coming quarters. We expect ANC shipment to increase slowly but surely in the second half this year. As for the whole TWS market, we saw Apple TWS outperform Android camp so far. Such time may turn in the second half of the year.
Thank you. The next question is from Randy Abrams, Credit Suisse, regarding the Wi-Fi spec upgrade. How does the dollar content changes, moving from 802.11n to 802.11ac and to 802.11ax? How do you see your position on Wi-Fi 6 versus the prior generation?
Well, first, in terms of the price ASP, on average, we are still observing a significant gap. If n being one, ac would be two, and ax will be 4.5. Still a significant gap between each generation. It is worth noting that COVID-19 seems to accelerate the migration of 11n to 11ac. In Q2, Realtek shipment split of 11ac versus 11n was about 60/40 on revenue basis. The ramping up of 11ax may still take time, as we predicted in the beginning of the year. For example, we still estimate only 10%-20% of notebooks will have 11ax in 2020. Perhaps growing to 20%-30% in 2021. Realtek is picking up on rolling out 11ax. Our first generation 11ax Wi-Fi 6 product is currently in MP. We have the R2, the next generation Wi-Fi 6, under development and with an MP schedule roughly the same as our competitors.
We do see ourselves remain a strong competitor in the overall Wi-Fi market.
Thank you. Next question is from Martina Huang, Fubon. She would like to ask about the addressable market of automotive Ethernet in two to three years, and the market share Realtek is targeting.
Okay. In terms of the automotive Ethernet, currently our team are pretty much working on 2023, 2024 projects. Our observation assessment is that more than 50% of the new cars by 2023 are expected to equip with Ethernet. While each car may have 20-40 Ethernet ports per car. Hopefully that gives you an idea of the size of the available market. Realtek expects to command a market share as strong as our competitors.
Thank you. The next question is raised by Bruce Lu, Goldman Sachs, on the company's initial view on 2021. Given the strong consumer replacement cycle for this year, is it possible for a weaker coming year?
Previously, we touched upon a few main product segments, and if you remember, we were generally optimistic about 2021. That's what we see. We see multiple technology migrations and new end applications taking place as we speak and into 2021. In technology, you heard Wi-Fi 6, 2.5 Gb per second Ethernet, managed switch, 10G-PON, BLE audio. In terms of new applications, we continue to be amazed by different types of IoT products, wearables, and also in broadband application to provide faster and more connectivities.
Okay. Thank you. Next question is from Kevin Wang, Mizuho. Please provide some colors on the status of China telco bidding. Do we see potential share gain in the near future? Will it be technology migration from Wi-Fi 5 to Wi-Fi 6 next year?
Yes, we do see new tender projects coming out in China in the second half of this year. It should be also mentioned that the first half of the year, even though China tender projects was quiet, not so in the rest of the world. Overall, the tender projects still very much alive and kicking. Wi-Fi 6 upgrade for this segment is well within expectation, especially to pair with 10G-PON and routers.
Thank you. Next question is from Warren Chu, Prudential. Please comment on the status of the IP K product development, even though it's still small to the company.
Indeed, it is still small in the company, the development is ongoing. Progress steadily. We do look forward to better sales results in the days to come. For now, suffice to say, the progress is steady and looking good.
Okay. Thank you. Next question is from Edward Su, Grand Alliance. Recently, we are seeing the TV supply chain start to build up inventory. Do we also benefit from it? How do we expect the 4K penetration compared to 2019 and the first half 2020?
Indeed, we are seeing our customers increasing their orders for the second half of the year. Note that, though, we see stronger demand in Full HD over 4K during COVID-19. Now we expect 4K penetration to slow down a bit in the near term, perhaps reaching 55% in 2020.
Okay. Thank you. Next question is from Rick Hsu, Daiwa. For margin side, could we expect that third quarter 2020 gross margin to be below Q2 level as the TV SoC recovering in third quarter? Also on the New Taiwan dollar appreciation impact on the margin.
Well, although we have said that TV is picking up in second half, we did say before TV has lower gross margin, a single product line wouldn't decide the final gross margin for Q3. We'll have to wait and see. Wait for the final product mix when the quarter is over to see that. In terms of impact of Taiwan dollar appreciation on gross margin, there should be none, because Realtek buy and sell are all done in U.S. dollar. Okay.
Okay. Thank you. Now is the questions from Sebastian Hou, CLSA. Realtek is focused on the smartphone IoT applications. Is it mainly home appliance consumer in China? What are the target customer profile look like? Who are the key competitors in IoT market competing on Wi-Fi plus Bluetooth solutions with Realtek?
In terms of the IoT, indeed, a few years ago, we started from the China market. By now, we pretty much are all over the world. Suffice to say that most of the well-known consumer home appliance brands are all adopting Realtek IoT solution by now. We have a pretty solid position in this segment. In terms of competition, IoT competition, certainly, we do run into MediaTek now and then. Overall, we have different focus in our end market application. Also, we do run across a few Chinese indigenous players in this segment, IoT segment. It's safe to say that Realtek IoT solution has much more field-proven records and broader product portfolio. We do have a much stronger position compared with our competition. Okay.
Okay. Thank you. Next question is from William Yang of JPMorgan. Please comment on the automotive Ethernet progress. Who are the major competitors, and what are the edges of Realtek?
We just mentioned that our automotive sales team are working on 2023, 2024 design-ins, and we are expecting good results. In terms of competition, we still see the stronger ones are Marvell and Broadcom. Having said that, we are happy to say that we have a very obvious competitive edge against our competition. It's in reliability. After more than a year of MP shipment to our customers, our RMA field return, any problem from these customers or the Tier 1, we have zero report of problems. This really delights OEM and Tier 1 customers. This is becoming our competitive edge. Okay.
Okay, thank you. The next question is from Yi-Ho Liu, Capital Investment. There are two questions. The first one is, could you provide the revenue guidance for the third quarter 2020? The second question is, excluding the Chromebook related application, the revenue of the PC application still increase in third quarter?
We are opt out on giving revenue guidance here. Realtek does not give revenue guidance. Suffice to say, as we say, we are optimistic about Q3. In terms of PC segment, excluding Chromebook, whether there's still an increase or not. This one, actually, I do not have data. When we compile the data, we do not separate that out. We consider Chromebook part of the PC segment. We acknowledge that some of the research reports, they do separate that out. In Realtek, we group them together, so I'm not able to comment on if separate them out, what would it look like.
The next question is from Alex Chu. This question is about the PON controller. When do we see the 2.5 Gb PON will migrate to 10G-PON? The impact of China-U.S. trade war on China PON controller competition, do we see more opportunity to growth in the future?
2.5G to 10G migration is happening as we speak, but slower than our expectation. As for when it may speed up, it is a little bit hard to be precise. We do believe it will happen sooner than later. Regarding the impact of U.S.-China trade war on PON controller supply, I guess the answer here is, whenever a company decide to exclude certain suppliers who are Realtek competitors, then it opens up opportunities for Realtek. In that sense, yes, Realtek will be a beneficiary if, because of the trade war, certain buyer will want to exclude some existing supplier. Okay?
Okay. Thank you. The next question is also from Randy, Credit Suisse. He would like to ask, do we see any areas of slowdown in the third quarter?
Any area of slowdown. At this moment, the continuous strength in PC segment, communication segment, and even consumer segment are coming back. Those are the three major segment Realtek plays in. Of course, the whole industry has more segment than these three. At least for the three major segment Realtek plays in, it pretty much is all good news at this moment. We do acknowledge maybe some other area, Realtek is not so strong a player. There may be certain slowdown. I guess, we are now all overwhelmed by what's happening in terms of customer demand. Okay.
Okay. There's only one question left. It's also from Randy from Credit Suisse. This question is related to the telecom projects. What is the outlook for growth in telco projects this year, and how many more are the new opportunities, like the managed switch and mesh routers?
Managed switch and mesh routers are very, very meaningful for Realtek. They are very real demands growing. What's the first part of the question again?
The first part of the question is the outlook for growth in the telco project.
Okay. The outlook of the telco project. Overall, we believe it's all part of the equation to provide more connectivity worldwide. I think we mentioned earlier, even when China tender projects was more or less quiet in the first half of the year, it wasn't so for the rest of the world. Long answer short here, I would say the outlook for the telco tender project is still a very important part of growth for Realtek.
The last question is from Rick, Daiwa. The question is related to the PC outlook. Would Realtek expect that PC market to have a correction in fourth quarter, or expect a normal seasonality in fourth quarter 2020?
That actually is a very frequently asked question. Currently, we tend to look at this problem more on overall yearly basis, because Q4 is a little bit hard to comment at this time. When we try to gauge what may happen in Q4, we look at overall, this PC market may be. We believe the overall PC market will be about the same as last year. The first half, we have seen the result is roughly the same as last year as well. Since last year, the second half is bigger than the first half. We can only go as far as to expect the second half of this year will be larger than the first half, even after a very strong growth in second quarter. Of course, we already say third quarter is also very strong. You can put all those together.
That's how we try to gauge it. Beyond that, it will be very difficult to pinpoint what may happen on Q4.
Okay. Thank you. I think we still have more time for one more question. It is also from Randy, Credit Suisse. He would like to ask, how is your view to sustain 42%-44% gross margin and also grow OPEX in line with the sales in the near future and longer term?
The intention or the goal to maintain 42%-44% is not a new goal, not a new target. We've been taking that challenge year-after-year. We've been able to maintain that. I want to say that moving forward, we accept the same challenge. At this point, we really find no reason to give up on this goal or say the goal is becoming impossible. We find no reason to say that for the gross margin. For the operating?
OpEx.
OpEx. For OpEx, earlier we say, we have been roughly at the 33% range for a couple of three quarters, around that. That seems to be a reasonable range there. Having said that, we will continue to look for this operational leverage as we continue to scale up. Of course, the major area for that to do is in the R&D, this category of the OpEx. That will be our continuing focus to apply or to expect operational leverage.
Okay. Thank you. 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, and have a good afternoon.